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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
Commission file number 000-23481
ESG RE LIMITED
(Exact name of Registrant as specified in its charter)
Bermuda Not Applicable
(State or other jurisdiction of (I.R.S. Employer Identification No.)
ncorporation of organization)
16 Church Street
Hamilton HM11, Bermuda
(Address of executive offices, zip code)
(441) 295-2185
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Common Shares, $1.00 par value
Name of each exchange on which registered
Nasdaq National Market
Securities registered pursuant to Section 12(g) of the Act:
3,000,000 Common Shares
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |X|
The aggregate market value of the voting stock held by non-affiliates of the
Registrant, as of March 22, 1999, was $197,124,329.63 based on the closing price
of $16.375 on that date.
The number of the Registrant's common shares (par value $1.00 per share)
outstanding as of March 22, 1999, was 13,923,799.
Documents Incorporated by Reference:
Certain portions of the Annual Report to Shareholders for 1998 (the "Annual
Report") are incorporated by reference in Parts II and IV of this Form 10-K.
Certain portions of the Definitive Proxy Statement in connection with the 1999
Annual General Meeting of Shareholders (the "Proxy Statement") which will be
filed with the Securities and Exchange Commission not later than 120 days after
the Registrant's fiscal year ended December 31, 1998, are incorporated by
reference in Part III of this Form 10-K.
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PART I.
Unless the context requires otherwise, references herein to the "Company"
or "ESG Re" include the Company's subsidiaries through which the Company
operates. All references to the Company prior to the closing of its initial
public offering on December 12, 1997, are to the Company's reinsurance
management business, which was conducted through its subsidiary, European
Specialty Group Holding AG ("ESG Germany") and its subsidiaries (together with
ESG Germany, "ES Management").
ITEM 1. BUSINESS
General
ESG Re Limited (the "Company" or "ESG Re") was formed on August 21, 1997,
under the laws of Bermuda. The Company, through its wholly owned direct and
indirect subsidiaries, European Specialty Reinsurance (Bermuda) Limited ("ES
Bermuda"), European Specialty Reinsurance (Ireland) Limited ("ES Ireland") and
European Specialty Ruckversicherung AG ("ES Germany"), is a specialty reinsurer
providing innovative risk solutions and capacity on a global basis in the fields
of accident, health, life and special risk reinsurance to insurers and selected
reinsurers. On December 12, 1997, the Company raised gross proceeds of $257
million in a private placement and initial public offering (the "Offerings").
The net proceeds from the Offerings of the Company's common shares in December
1997 provided the capitalization for the Company to assume reinsurance risks.
In June 1998, the Company incorporated Accent Insurance Company Ltd.
("Accent") in Ireland, enabling it to offer its products on a pan-European basis
directly to its insured parties. In the former Soviet State of Georgia, ESG Re
has helped to establish the first locally-managed insurance company to be run
along Western business standards, supplying a range of innovative products and
services, extensive management and training support, technical expertise and
capital funding. The Company has also established operations in the Latin
American market and has increased its presence in the London, North American,
and Asian markets. The Company has increased its investment in SportSecure GmbH,
a reinsurance intermediary specializing in sports and entertainment risks,
giving the Company a majority ownership interest and securing a leadership
position in the Special Risk market.
The Company distinguishes itself by offering "intelligent reinsurance"
products and services for particular underwriting problems including actuarial
support, product design, and, in the field of medical expense reinsurance, loss
prevention and disease management. ESG Re believes that "intelligent
reinsurance" products combined with management's experience, extensive
relationships, market reputation, underwriting skills, and a strong balance
sheet will produce a solid book of business characterized by high stability,
above average performance, broad product and global diversity and strong growth
opportunities.
Market Growth
The Company believes that it is well positioned to benefit from market
growth developments because of its reputation as a recognized lead underwriter,
risk-oriented approach and far-ranging and well-established relationship
network. ESG Re believes that its reinsurance markets are currently experiencing
significant growth as a result of: (i) the worldwide trend of transferring
social security and national health responsibility to the private sector; (ii)
increasing insurance demand accompanying economic growth in emerging markets in
Eastern Europe, Asia and Latin America; (iii) the deregulation of certain
European markets as a consequence of new trade directives from the European
Union enabling the introduction of new products; (iv) increasing individual
morbidity and decreasing mortality within large demographic segments of the
population; and (v) increased capacity requirements for the insurance of major
global sports and entertainment events.
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Business Strategy
The Company's strategy places an emphasis on underwriting profitability
rather than market share. The Company intends to achieve its growth objectives
through the following strategic initiatives:
Products and Services
Management believes that the Company is recognized by customers as a
provider of "intelligent reinsurance" through innovative insurance products and
services. ESG Re intends to maintain its competitive advantage by developing
reinsurance products and services that are tailored to the needs of particular
markets and by working closely with primary insurers and insureds to implement
loss control techniques. The Company intends to (i) introduce and implement
managed care techniques in selected European markets where these techniques have
been underutilized; (ii) create private medical care and insurance products for
emerging markets within Eastern Europe, Latin America and Asia; (iii) expand
occupational injury and health reinsurance programs in Scandinavia; and (iv)
continue to structure innovative special risk reinsurance programs for major
sporting events and performances such as Soccer World Cup, and European Soccer
Championships. Consistent with its practice and experience, ESG Re offers
reinsurance of health risks in conjunction with loss-reducing products and
services. The Company expects that its ceding clients will assist with the use
and implementation of such products and services because of their favorable
impact on claims expenses.
In support of its loss prevention programs, the Company also provides
claims assistance services that were previously provided by third parties.
Assistance services include such functions as 24-hour emergency evacuation and
repatriation, medical treatment referrals and supporting clinical services. In
addition, the Company uses the European Specialty Insurance Management Services
("ESIMS") software system developed by the Company to assist ceding companies
with portfolio and claims handling.
New Businesses and Markets
The Company entered the North American market in September 1997. Ms.
Renate M. Nellich, Chief Executive Officer of European Specialty (North America)
Limited ("ES North America"), has considerable experience in the North American
health business and is pursuing opportunities in this market. In addition,
access to specialized U.S. claims service providers and the consummation of
strategic alliances will enable the Company to import managed care techniques
that have proven successful in the United States, to Europe and other areas
where they are currently underutilized by health care providers.
Focus on High Growth Markets
ESG Re focuses its health insurance underwriting activities on markets
with high growth potential in developing areas such as Latin America, the
Commonwealth of Independent States ("CIS"), Eastern Europe and Asia. The Company
also targets selected developed markets for the introduction of innovative
products. In Germany, for example, the Company is introducing progressive
technologies that will establish new and more streamlined distribution channels.
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Lines of Business
The Company's major lines of business include medical expense, personal
accident and disability, credit, life and special risk reinsurance. ESG Re's
gross premiums written in 1998 totaled $199.9 million. The breakdown of gross
premiums written for the year ended December 31, 1998 by major lines of business
was as follows:
<TABLE>
<CAPTION>
1998 Gross
Premiums
Written
<S> <C>
Medical Expense...................................................... 59.6%
Personal Accident and Disability..................................... 26.1
Credit............................................................... 6.2
Life................................................................. 5.5
Special Risk......................................................... 2.6
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100.0%
</TABLE>
FURTHER SEGMENT INFORMATION IS DISCLOSED IN NOTE 16 OF THE CONSOLIDATED
FINANCIAL STATEMENTS INCORPORATED BY REFERENCE FROM THE 1998 ANNUAL
REPORT TO SHAREHOLDERS.
Medical Expense
Medical expense reinsurance consists primarily of medical expense
reimbursement plans, short-term travel, defined illnesses and dread diseases, as
well as medical expense add-on coverages, top-up benefits and carve-out
programs. To properly evaluate these reinsurance risks, ESG Re relies on its
detailed knowledge of the underlying insurance product and active risk
management, instead of relying solely on past performance or general market
pricing. ESG Re frequently underwrites risk only concurrently with the
implementation of the Company's loss control measures and underwriting support
systems. The Company generally does not underwrite business where the insured
has no deductible or co-payment without being able to influence its loss ratios
(by applying cost containment measures whenever prudent). To this end, the
Company generally seeks to have insurers include deductibles and coinsurance
requirements in the primary insurance contracts. In developing countries, ESG Re
encourages ceding clients to develop adequate retention levels.
ESG Re encourages its ceding clients to employ stringent cost control and
loss prevention measures, such as managing a patient's choice of doctors and
hospital networks, reducing benefit utilization and minimizing claims patterns.
The Company introduces selected managed care concepts in Europe and emerging
insurance markets through "intelligent reinsurance" (i.e., the combination of
capacity, system and data management support and the application of preventative
loss control). The Company believes insurance companies in these markets are
receptive to managed care since they often have less experience with
contemporary cost-containment measures.
ESG Re believes that medical expense reinsurance is one of the strongest
growing classes in the insurance industry. The restructuring of social security
systems throughout numerous countries generates the need for private insurance
and, consequently, generates reinsurance demand. New markets have emerged
particularly in Eastern Europe, due to changes in laws that have transferred
insurance responsibility from government funds to private institutions, such as
trade unions.
In the area of health reinsurance, ESG Re has focused its underwriting
activities on both highly developed markets, like Germany, and less developed
markets with high growth potential, like Latin America, the CIS, Eastern Europe
and Asia.
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Personal Accident
Personal accident reinsurance covers death and dismemberment, disability,
loss of license and special coverages for credit card issuing corporations
relating to injuries to card holders. The reinsurance of nontraditional risks,
such as tailor-made coverage for occupational injuries, also comprises an
important part of ESG Re's personal accident reinsurance business. The Company
favors the "local approach" to personal accident reinsurance (i.e., it acquires
direct knowledge of the underlying business by establishing personal
relationships and transacting business directly with the ceding clients or local
brokers in the country of origin). ESG Re focuses its business in areas in which
it has detailed knowledge of local culture, insureds' behavior, market
conditions and other risk elements, since such knowledge allows the Company to
assess and price risk appropriately.
Credit/Life
ESG Re provides reinsurance for credit/life, accident, disability and
unemployment insurance. ES Management has considerable experience underwriting
credit/life reinsurance in the American, French and Scandinavian markets. In
1998, the Company has entered the German and selected other European markets for
credit/life reinsurance, applying the same underwriting practice it has employed
in its existing markets (with the necessary adaptations for local markets). The
Company has recently begun underwriting activities in the area of traditional
life reinsurance, initially limited to developing markets. Because the Company
does not intend to compete with established insurers and reinsurers in long-term
life insurance or investment-related life products, it seeks to offer these
products in less established markets.
Special Risk
Special risk reinsurance includes insurance with unique risk
characteristics, such as sports disabilities, sports and entertainment
contingency, non-appearance, cancellation and abandonment. For example, for the
1998 World Cup Soccer Tournament, ES Management controlled the placement of
largest contingency insurance risk ever arranged in the global market. The
Company has also been selected to structure and arrange the 2002 Soccer World
Cup, with a record amount insured of over 2 billion Swiss francs. ES Management
has also covered the 1994 World Soccer Tournament, the European Soccer
Championships, the World Athletic Championship, the ATP finals, the European
Athletic Association Cups and numerous performances by internationally renowned
artists.
Underwriting
The Company employs a disciplined, analytical and forward-looking approach
to underwriting in order to maximize underwriting profitability. The Company
intends to construct a portfolio of reinsurance contracts in the personal and
special risk markets that maximizes shareholders' return on equity, subject to
prudent risk constraints.
ESG Re's continued success rests squarely on its ability to generate
consistent underwriting profits. Underwriting profits, not cash flow
underwriting or investment speculation, are the cornerstone of the Company's
profit strategy.
Management believes that its strategy of "intelligent reinsurance"
provides the appropriate tools for achieving the Company's mission. This is
evidenced by the Company's underwriting performance, with combined loss and
acquisition expense ratios of 89.1% and 90.5% for the years ended December 31,
1998 and 1997, respectively. ESG Re's products and services also serve to
enhance the persistency of the portfolio, which in turn supports long-term
profitability. With an emphasis on underwriting profitability, the Company has
canceled contracts with ceding companies when underwriting profits were not in
line with expectations.
Underwriting new and renewal business is conducted on a risk-by-risk
basis, with consideration given to the general direction of rates, policy terms,
loss histories and future exposures, ESG Re's acceptance limits and general book
of business. As part of its underwriting process, the Company focuses on the
reputation of the proposed cedent, the likelihood of establishing a long-term
relationship with the cedent, the geographic area in which the cedent conducts
business and the cedent's market share. The Company reviews historical loss data
in order to compare the cedent's
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historical loss experience to industry averages, as well as the perceived
financial strength of the cedent. Over time, the Company has developed its own
manuals that serve as a detailed underwriting guideline.
The Company protects its portfolio by effecting non-proportional
reinsurance coverage in various layers to protect against large individual
losses, serial losses and risk of known and unknown concentration. In addition,
the Company will continue to effect proportional coverage on underwritten risks
that might have fluctuating results.
The Company, together with co-reinsurers, provides initially the
following gross capacities:
<TABLE>
<S> <C>
Medical Expense $5 million lifetime benefit per person
Personal Accident and Disability $5 million any one person and $30 million in accumulated
losses from any one known event
Credit/Life $5 million any one person
Special Risk $10 million any one event or series of events
</TABLE>
Initially, the Company does not intend to expose itself to risk for any
individual in excess of $500,000 for personal accident, special risk, medical,
life and credit/life reinsurance, $1 million for any one known accumulation and
$2,500,000 for contingency for major events, prior to additional reinsurance.
Claims
Normally, a reinsurer is not actively involved in claims handling. It is
the task of the ceding client to adjust the original losses and settle claims
made by its direct insureds. To the extent possible, the Company's approach
differs from other reinsurers in that it actively seeks to reduce risks in most
of its medical expense reinsurance lines while its reinsurance policies are in
effect.
The Company's claims handling activities, particularly for complicated
cases, have proven to be successful in significantly reducing loss ratios of
ceding clients' portfolios in comparison to their loss ratios before ESG Re's
involvement. Involvement in claims handling also will allow the Company to be
constantly aware of claims development in the health care field and to establish
reserves more accurately at an early point in time. These claims support
techniques have also proven to be an important tool in the acquisition of new
business.
Depending on the experience and the retention of the ceding client and the
extent of non-proportional reinsurance made available to the Company, it will
require either claims control or claims cooperation clauses in the reinsurance
treaties it negotiates. Claims control clauses allow the reinsurer to determine
the extent to which a claim will be paid, whereas claims cooperation clauses
require the agreement of the insurer and reinsurer to jointly determine the
extent to which a claim will be paid. These clauses may improve the claims
performance of a ceding client which might not always be sufficiently
experienced in dealing with complex issues.
The Company performs audits at its ceding clients where deemed necessary.
Such audits may include underwriting, claims, financial, and systems audits.
Qualitatively, such audits do not serve solely to test compliance, but to
discover weaknesses in the reporting and reserving system of a ceding client and
thereby help the ceding client to arrive at a realistic and timely methodology
to evaluate risk exposure.
Operations
The Company has structured its underwriting operations according to
business lines. Underwriters are responsible for underwriting the business
according to internal guidelines and procedural and underwriting manuals, as
well as for supervising claims and handling claims subsequent to entering into
the contracts. All business is continuously monitored.
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The Company's management and underwriting information system provides a current
database for individual and general risk assessment.
In November 1998, the Company announced the opening of a new Shared
Services Support Center in Dublin, Ireland, providing centralized global
operational support for insurance administration, finance, systems and human
resources. The consolidation of these services established the operating
platform necessary to support and enhance the Company's accelerated growth and
development to supply value-added leading edge services and to enable the
Company to contain future costs in an increasingly competitive marketplace.
The Company has entered into agreements with various companies for the
provision of office space, certain administrative services, and accounting and
regulatory reporting support in Ireland and Bermuda.
Reserves
The Company expects that, due to the short-tail nature of personal and
special risk reinsurance claims, most claims under its treaties will generally
become known and ascertainable within approximately 12 to 24 months from the
date the insurance policy is written. However, a portion of the Company's
business, written and classified as typical "London market business," is
generally longer-tail in nature. The majority of the Company's reinsurance
contracts permit annual adjustment of terms.
The reserve for unpaid losses and loss adjustment expenses includes an
estimate of reported case reserves and an estimate for losses incurred but not
reported. Case reserves are estimated based on ceding company reports and other
data considered relevant to the estimation process. The liability for losses
incurred but not reported is based to a large extent on the expectations of
ceding companies about ultimate loss ratios at the inception of the contracts,
supplemented by industry experience and the Company's specific historical
experience where available. As the Company has limited specific historical
experience on a significant number of its programs on which to base its estimate
of losses incurred but not reported, its reliance on ceding company expectations
and industry experience is necessarily increased, which increases the
uncertainty involved in the loss estimation process. The reserves as established
by management are reviewed periodically, and adjustments are made in the periods
in which they become known. Although management believes that an adequate
provision has been made for the liability for losses and loss expenses, based on
all available information, there can be no assurance that the ultimate losses
will not differ significantly from the amounts provided.
Investments
As of December 31, 1998, the Company's cash and invested assets totaled
$235.2 million. The Company has developed specific investment guidelines for the
management of its investment portfolio. Although these guidelines stress
diversification of risk, preservation of capital and market liquidity,
investments are subject to market risks and fluctuations, as well as to risks
inherent in particular securities. The Company's primary investment objective
for the portfolio is to preserve the capital assets of the Company while
achieving a total return commensurate with market conditions.
The Company has allocated up to $25 million to fund "strategic
investments." Strategic investments represent equity investments in, and loans
to, reinsurance related enterprises, ceding companies or distribution channels
that are expected to generate or secure additional profitable business for the
Company. At year end, 1998, ESG Re had invested $5.9 million into four such
enterprises with a further $2 million invested in its majority owned Georgian
subsidiary, IMEDI L. Insurance Company Limited ("IMEDI").
The Company has entered into an Investment Advisory Agreement with Head
Asset Management L.L.C. to supervise and direct the investment of the Company's
asset portfolio in accordance with, and subject to, the investment objectives
and guidelines established by the Company. Pursuant to the terms of the
Investment Advisory Agreement, the Company will pay a fee, payable quarterly in
arrears, equal to 0.25% per annum of the first $200 million of assets under
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its management declining to 0.15% per annum of the assets under its management,
in excess of $200 million. The Investment Advisory Agreement may be terminated
upon 90 days written notice by the Investment Advisor or by the Company on five
days notice or upon shorter notice upon mutual written agreement by the parties.
See "Certain Relationships and Related Transactions." The performance of, and
the fees paid to, the Investment Advisor will be reviewed periodically by the
Board of Directors.
Maturity and Duration of Portfolio
The maximum effective maturity for any single security in the Company's
investment portfolio is set at 30 years for U.S. government and U.S. government
agency securities with full faith and credit guarantees and at 10 years for all
other issues, measured from the date of settlement. The duration of the
portfolio varies according to decisions taken by the Investment Advisor on the
outlook for interest rate movements. The benchmark for such duration is
approximately 3 years.
Quality of Debt Securities in Portfolio
The minimum average credit quality of the Company's investment
portfolio is AA.
Equity Securities and Real Estate
The Company does not currently intend to invest any of its portfolio in
publicly traded equity securities, although it may consider doing so in the
future. Private equity investments ("strategic investments") have been placed
with strategic partners in order to support ESG Re's core business or to secure
distribution. The Company does not intend to invest in real estate other than
for its own use.
Diversification and Liquidity
No more than 3% of the Company's investment portfolio may be invested in
the securities of any single issuer, with the exception of sovereign governments
or agencies, including supranational agencies, with an AA rating or better.
Foreign Currency Exposures
The Company's investment portfolio is invested predominantly in fixed
income securities denominated in U.S. dollars, Euros and German Marks. The
Company's primary risk exposures and premiums receivable are denominated
predominantly in U.S. and Canadian dollars and European currencies. The Company
intends to hold investments in the currencies in which it will collect premiums,
pay claims and hold reserves thus creating a partial natural foreign exchange
hedge against exchange rate fluctuations.
Competition
The reinsurance industry is highly competitive. The Company competes with
other reinsurers, some of which have substantially greater financial, marketing,
and management resources than the Company. It may also compete with new market
entrants in the future. Management believes that virtually all major reinsurers
write personal accident business, mainly through their property and casualty
departments. A smaller number engage also in the fields of health, credit/life
and special risks. On an international basis, excluding carriers which are
predominantly focused on the United States, few reinsurers are considered lead
reinsurers in the segments in which ESG Re is active. In other markets, however,
certain traditional or domestic reinsurers hold a dominant position, creating
highly competitive market conditions.
Most reinsurers provide capacities for the various classes of personal
reinsurance through discrete units or profit centers. ESG Re believes that it
will benefit from being a flexible, innovative specialty reinsurer with its
focus on
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personal and special risk reinsurance (allowing specialized risk solutions from
one source).
Employees
As of December 31, 1998, the Company had 76 employees. None of these
employees is represented by a labor union. The Company expects to add additional
underwriting, marketing and administrative staff consistent with the
implementation of the Company's business plan. The Company believes that its
employee relations are generally good.
Regulation
Bermuda
The Companies Act 1981 (as amended) and Related Regulations. The Companies
Act regulates the business of both the Company and ES Bermuda.
The Insurance Act 1978 (as amended) and Related Regulations. The Insurance
Act 1978 of Bermuda (as amended) and related regulations from time to time in
force (the "Act"), which regulates the business of ES Bermuda, provides that no
person shall carry on an insurance business in or from within Bermuda unless
registered as an insurer under the Act by the Minister of Finance. The Minister
of Finance, in deciding whether to grant registration, has broad discretion to
act as he thinks fit in the public interest. The Minister of Finance is required
by the Act to determine whether the applicant is a fit and proper body to be
engaged in insurance business and, in particular, whether it has, or has
available to it, adequate knowledge and expertise. In connection with
registration, the Minister of Finance may impose conditions relating to the
writing of certain types of insurance.
An Insurance Advisory Committee and sub-committees thereof appointed by
the Minister of Finance advises him on matters connected with the discharge of
his functions and supervise and review the law and practice of insurance in
Bermuda, including reviews of accounting and administrative procedures.
The Act imposes on Bermuda insurance companies solvency and liquidity
standards and auditing and reporting requirements and grants to the Minister of
Finance powers to supervise, investigate and intervene in the affairs of
insurance companies. Significant aspects of the Bermuda insurance regulatory
framework are set out below.
Cancellation of Insurer's Registration. An insurer's registration may be
canceled by the Minister of Finance on certain grounds specified in the Act,
including failure of the insurer to comply with its obligations under the Act or
if, in the opinion of the Minister of Finance, after consultation with the
Insurance Advisory Committee, the insurer has not been carrying on business in
accordance with sound insurance principles.
Independent Approved Auditor. Every registered insurer must appoint an
independent auditor who will annually audit and report on the statutory
financial statements and the statutory financial return of the insurer, which
are required to be filed annually with the Registrar of Companies (the
"Registrar"), who is the chief administrative officer under the Act. The auditor
must be approved by the Minister of Finance as the independent auditor of the
insurer. The approved auditor may be the same person or firm which audits the
insurer's financial statements and reports for presentation to its shareholders.
Statutory Financial Statements. An insurer must prepare annual statutory
financial statements. The Act prescribes rules for the preparation and substance
of such statutory financial statements (which include, in statutory form, a
balance sheet, income statement, statement of capital and surplus, and detailed
notes). The insurer is required to give detailed information and analyses
regarding premiums, claims, reinsurance and investments. The statutory financial
statements are not prepared in accordance with U.S. GAAP and are distinct from
the financial statements prepared for presentation to the insurer's shareholders
under The Companies Act 1981 of Bermuda, which financial statements may be
prepared in accordance with U.S. GAAP. Copies of the Company's and ES Bermuda's
statutory financial statements must be filed annually together with its
statutory financial return. The statutory financial statements must be
maintained
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at the principal office of the insurer for a period of five years.
Minimum Capital and Surplus. Under the Act, ES Bermuda has been designated
as a Class 3 composite insurer. The Act requires $1.25 million minimum capital
and surplus for Class 3 composite insurers (i.e. insurers which write both
general business and long-term business) with a minimum paid up share capital of
$370,000.
Minimum Solvency Margin. The Act provides that the statutory assets of a
Class 3 insurer writing general business must exceed its statutory liabilities
by an amount equal to or greater than the applicable minimum solvency margin for
that class. The applicable minimum solvency margin for a Class 3 insurer is 20%
of net premiums written for the first $6 million of net premiums written plus
15% of net premiums written in excess of $6 million or 15% of loss and loss
expense reserves, whichever is greater. The minimum solvency margin for writers
of long-term business is $250,000.
Minimum Liquidity Ratio. The Act provides a minimum liquidity ratio for
insurers which write general business. An insurer engaged in general businesses
is required to maintain the value of its relevant assets at not less than 75% of
the amount of its relevant liabilities. Relevant assets include cash and time
deposits, quoted investments, unquoted bonds and debentures, first liens on real
estate, investment income due and accrued, accounts and premiums receivable,
reinsurance balances receivable and funds held by ceding reinsurers. There are
certain categories of assets which, unless specifically permitted by the
Minister of Finance, 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) and
certain letters of credit and guarantees.
Statutory Financial Return. A Class 3 insurer is required to file with the
Registrar an Annual Statutory Financial Return at the same time as it files its
Statutory financial statements but, in any event, no later than four months from
the insurer's financial year end (unless specifically extended). The Statutory
Financial Return includes, among other matters, a report of the approved
independent auditor on the Statutory financial statements of the insurer, a
schedule of ceded reinsurers, an annual actuarial opinion on loss reserves
prepared by the approved loss reserve specialist and a declaration of the
statutory ratios and a solvency certificate.
Supervision, Investigation and Intervention. The Minister of Finance may
appoint an inspector with extensive powers to investigate the affairs of an
insurer if the Minister of Finance 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 of Finance may direct an insurer to produce documents or
information relating to matters connected with the insurer's business.
If it appears to the Minister of Finance that there is a risk of the
insurer becoming insolvent, the Minister of Finance 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.
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 Company and to report to the Minister of Finance and the
Registrar of Companies in respect of certain events. Unless the approval of the
Minister of Finance has been 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
of Finance is given of the intention to do so. It is the duty of the principal
representative, within 30 days of his reaching the view that there is a
likelihood of the insurer, for which he acts, becoming insolvent or its coming
to his knowledge, or his having reason to believe, that an "event" has occurred,
to make a written report to the Minister of Finance setting out all the
particulars of the case that are available to him. Examples of such an "event"
include failure by the reinsurer to comply substantially with a condition
imposed upon the reinsurer by the Minister of Finance relating to a solvency
margin or a liquidity or other ratio.
Dividends. The Bermuda Companies Act 1981 would allow dividend payments
when there are reasonable
10
<PAGE> 11
grounds for believing that (i) ESG Re will be able to pay its debts as they fall
due after payment of a dividend, and (ii) ESG Re's assets will exceed the
aggregate value of its liabilities and its issued share capital and premium
accounts. The Bermuda Insurance Act 1978 requires ES Bermuda to maintain a
minimum solvency margin and a minimum liquidity ratio.
Reduction of Statutory Capital. Approval is needed from the Minister of
Finance for any reduction in total statutory capital of an insurance company of
15% or more. Applicants are required to show that the proposed reduction of
capital will not cause ES Bermuda to fail to meet applicable statutory margin
requirements in Bermuda.
Germany
The German regulatory framework for the insurance industry is provided by
the Insurance Supervisory Law (Versicherungsaufsichtsgesetz, or "VAG"). The
supervision of all insurance companies domiciled in Germany is the
responsibility of the BAV, which is an agency of the Ministry of Finance.
Other than the area of primary insurance, reinsurance has been largely
liberalized. Consequently, except as set forth under "European Union" below,
there are no detailed regulations for reinsurers under the law of the European
Union or Germany.
A professional reinsurance company requires no license from the BAV. Only
a summary filing is required, setting forth the domicile and corporate form of
the reinsurance company and the members of the executive and supervisory boards.
The BAV encourages reinsurers to submit the names of the company's shareholders
with such filings, and also to include the qualifications of the members of the
executive and supervisory boards. The submission of a business plan is not
necessary.
Insurance and reinsurance companies are under the direct supervision of
the BAV. For reinsurers, however, the level of supervision is substantially
relaxed, and pertains primarily to the financial supervision of reinsurers,
requiring only submission of financial statements. Except as set forth above,
the provisions of the VAG and the Capitalization Law (Kapitalausstattungs VO) do
not apply to reinsurers. Reinsurance mutuals (Ruckversicherungsverein VVaG) are
subject to solvency controls. Reinsurance companies, such as ES Germany, are not
subject to capitalization requirements, but the BAV prefers that reinsurance
companies have the same level of capitalization as primary insurers
(approximately 16- 18% of net premiums).
Sections 55-59 VAG, pertaining to accounting and auditing of insurance
companies, are also applicable to reinsurance companies.
Ireland
Irish law directly regulates only two of the Company's subsidiaries, ES
Ireland and Accent.
Regulation. Direct insurance business in Ireland is regulated by an
extensive list of acts and regulations from the Assurance Companies Act 1909 to
the Insurance Act 1989 and the European Communities (Non Life Insurance)
Regulations 1976 to the European Communities (Non Life Insurance) Framework
Regulations 1994. Direct insurance companies must be authorized by the Minister
for Enterprise, Trade and Employment (the "Minister") before commencing
business.
Specialist reinsurers incorporated in Ireland, such as ES Ireland, are not
subject to authorization by the Irish Government and are only required to notify
the Minister that they carry on the business of Reinsurance pursuant to Section
22 of the Insurance Act 1989.
Auditor's Report and Duties. The Companies Act 1963 requires all companies
incorporated in Ireland to prepare and have audited annual accounts for their
shareholders. Section 22(1) Insurance Act 1989 requires reinsurance
11
<PAGE> 12
companies to prepare their accounts in such form as the Minister may specify and
such audited accounts are required to be filed in the Companies Registration
Office and are available for public inspection.
Georgia
Georgia law directly regulates only one of the Company's subsidiaries,
IMEDI.
Regulation. The Georgian Parliament adopted Insurance Regulation in 1996
regarding foreign ownership and capitalization requirements. There are no
current requirements to cede any part of the reinsurance to a local Reinsurance
Company.
United States and Other
The Company is not admitted to do business in any jurisdiction except
Bermuda, Ireland, Germany and Georgia. The insurance laws of each state of the
United States and of many foreign countries regulate the sale of insurance
within their jurisdictions by alien insurers, such as the Company, which are not
admitted to do business within such jurisdictions. With some exceptions, such
sale of insurance within a jurisdiction where the insurer is not admitted to do
business is prohibited. The Company does not intend to maintain an office or to
solicit, advertise, settle claims or conduct other insurance activities in any
jurisdiction where the conduct of such activities would require that the Company
be so admitted and the Company is not so admitted.
ITEM 2. PROPERTIES
ESG Re leases office space in Bermuda, Dublin, Hamburg, Toronto, Miami,
Hong Kong and London and owns an office located in the Soviet State of Georgia.
The owned property is currently valued at $252,000. The Company believes its
space is adequate to meet its current and expected needs.
ITEM 3. LEGAL PROCEEDINGS
There are no lawsuits pending, or to the knowledge of the Company
threatened, to which the Company or any of its subsidiaries is a party or of
which any of their properties is subject other than routine litigation
incidental to the business.
PART II.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of fiscal 1998.
ITEM 5. MARKET FOR COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Market Information
Since December 12, 1997, the common stock of the Company has been traded
on NASDAQ under the symbol ESREF. The high and low market prices of the
Company's common stock for each fiscal quarter since December 12, 1997 were as
follows:
12
<PAGE> 13
<TABLE>
<CAPTION>
High Low
------------ ------------
<S> <C> <C>
From December 12 to December 31, 1997: $23.88 $21.50
From January 1 to March 31, 1998: $28.88 $21.00
From April 1 to June 30, 1998: $27.50 $19.88
From July 1 to September 30, 1998: $23.88 $13.50
From October 1 to December 31, 1998: $21.25 $12.75
</TABLE>
Number of Record Holders of Common Stock
The number of record holders of the common stock of the Company as of
March 22, 1999 was 30.
Dividend History and Restrictions
On March 9, 1998, the Board of Directors declared a cash dividend of
$0.075 per share payable April 3, 1998 to shareholders of record on March 28,
1998. On May 4, 1998, the Board of Directors declared cash dividend of $0.075
per share payable May 27, 1998 to shareholders of record on May 18, 1998. On
August 6, 1998, the Board of Directors declared a cash dividend of $0.075 per
share payable September 1, 1998 to shareholders of record on August 20, 1998. On
November 10, 1998, the Board of Directors declared a cash dividend of $0.075 per
share payable December 1, 1998 to shareholders of record on November 23, 1998.
On February 25, 1999, the Board of Directors declared a cash dividend of $0.08
per share payable March 22, 1999 to shareholders of record on March 15, 1999.
Restrictions on the payment of dividends is described in Item 1, "Regulation."
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
Selected Consolidated Financial Data of the Company is contained in the
Annual Report and is incorporated herein by reference in response to this item.
Reference is made to Item 14(a) of this Form 10-K.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
"Management's Discussion and Analysis of Financial Condition and Results
of Operations" is contained in the Annual Report and is incorporated herein by
reference in response to this item. Reference is made to Item 14(a) of this Form
10-K.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
"Management's Discussion and Analysis of Financial Condition and Results
of Operations" is contained in the Annual Report and is incorporated herein by
reference in response to this item. Reference is made to Item 14(a) of this Form
10-K.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's consolidated financial statements are contained in the
Annual Report and are incorporated herein by reference in response to this item.
Reference is made to Item 14(a) of this Form 10-K for the Financial Statement
Schedules.
13
<PAGE> 14
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
Executive Officers
The table below sets forth the names, ages and titles of the persons who
are executive officers of the Company and/or its principal operating
subsidiaries as of March 22, 1999.
<TABLE>
<CAPTION>
Name Age Position
<S> <C> <C>
Wolfgang M. Wand.......................... 46 Managing Director and Chief
Executive Officer
Steven H. Debrovner....................... 61 Chief Underwriting and Marketing
Officer
Renate M. Nellich......................... 60 Chief Executive Officer of ES North
America
Joan H. Dillard........................... 47 Chief Financial Officer
Gerhard Jurk.............................. 50 Audit and Compliance Officer
</TABLE>
Wolfgang M. Wand has been active in the insurance business for over 20
years, 17 of which were in the international insurance market. In 1983, Mr. Wand
founded a specialized health care insurance group in which Winterthur Insurance
Group acquired a majority interest in 1989 and a 100% interest in 1993. Later in
1993, Mr. Wand co-founded ESG Germany, through which the Company operated its
insurance businesses prior to the Offerings. Mr. Wand serves as a member of the
German delegation of the International Chamber of Commerce and is a
representative on the Chamber's Committee for insurance affairs in Eastern
Europe. Following the reunification of Germany, Mr. Wand served on behalf of the
German government's privatization agency, the Treuhandanstalt, in connection
with the privatization and restructuring of the East German economy, as Chairman
of the Board of Directors for certain segments of the German shoe manufacturing
industry from 1991 to 1992. Mr. Wand also acts as designated legal
representative of Les Mutuelles du Mans in Germany. Mr. Wand completed a degree
in economics in 1974 and studied at Cologne and Wuppertal Universities.
Steven H. Debrovner co-founded ESG Germany with Mr. Wand in 1993. From
1987 to 1992, Mr. Debrovner served as the head of marketing for all non-life
business at CIGNA Worldwide headquarters in Philadelphia. In 1974, he created
the European accident and health activities for AFIA and, subsequently, CIGNA.
Mr. Debrovner received a bachelor's degree in history from Duke University in
1959. Mr. Debrovner has more than 30 years of insurance underwriting experience,
having started with American International Group, Inc. in 1967. He has also been
both a student and lecturer in Harvard's Graduate International Marketing
Program.
Renate M. Nellich has been Chief Executive Officer of ES North America
since September 1997. Prior to that, Ms. Nellich was Chief Operating Officer of
Swiss Re Life and Health/Mercantile and General Life Reinsurance Company Limited
responsible for the Group Reinsurance Operation of the Americas from 1985 to
1997. Between 1975 and 1985, Ms. Nellich served in various capacities in the
Mercantile and General's North American Group Division. Ms. Nellich has more
than 25 years of experience in the North American life and health insurance
industry.
14
<PAGE> 15
Joan H. Dillard has been Chief Financial Officer of ESG Re since March,
1998. From 1993 to 1998, Ms. Dillard was Senior Vice President of TIG Insurance
Company in Dallas, Texas. During this time, she served in various positions such
as Chief Financial Officer of Personal Lines, Treasurer, and the Director of the
Alternative Distribution Business Unit. Between 1990 and 1993, Ms. Dillard acted
as Senior Vice President and Treasurer of USF&G Corporation in Baltimore,
Maryland. Prior to that, Ms. Dillard served as Treasurer of American General
Finance Company, Assistant Treasurer of American General Corporation and as
Financial Manager of The Johns Hopkins Hospital. She holds the CMA and ARM
professional designations. Ms. Dillard received a bachelor of art's degree from
the University of Maryland in 1977 and a master's of business administration
degree from the University of Baltimore in 1984.
Gerhard Jurk has been Audit and Compliance Officer of ESG Re since
December 1998 and served as Chief Financial Officer from 1996 to April 1998.
From 1992 to 1996, Mr. Jurk was Chief Internal Auditor of the Transatlantic
Insurance Group. In this function, he was a member of the audit team of
Winterthur Insurance Group. Between 1993 and 1996, Mr. Jurk acted as Chief
Executive Officer for a Winterthur Group underwriting subsidiary. Prior to that,
from 1984 to 1992, Mr. Jurk was the Chief Officer of the Financial and
Investment Department of the Transatlantic Insurance Group, then a subsidiary of
ITT Corporation and subsequently a subsidiary of Winterthur Insurance Group. Mr.
Jurk has worked in the insurance industry for more than 25 years and is an
accountant certified by the German government.
The information with respect to directors of the Company is contained
under the captions "Election of Directors" in the Proxy Statement and is
incorporated herein by reference in response to this item.
ITEM 11. EXECUTIVE COMPENSATION
The Information with respect to executive compensation is contained under
the caption "Executive Compensation" in the Proxy Statement and is incorporated
herein by reference in response to this item.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information with respect to security ownership of certain beneficial
owners and management is contained under the caption "Information Regarding the
Security Ownership of Certain Beneficial Owners, Management and Directors" in
the Proxy Statement and is incorporated herein by reference in response to this
item.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information with respect to certain relationships and related
transactions is contained under the caption "Certain Relationships and Related
Transactions" in the Proxy Statement and is incorporated herein by reference in
response to this item.
PART IV.
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES AND REPORTS ON FORM 8-K
(a) 1. FINANCIAL STATEMENTS:
The Company has incorporated by reference from the 1998 Annual Report to
Shareholders the following consolidated financial statements of the Company:
15
<PAGE> 16
<TABLE>
<CAPTION>
1998 Annual Report
to Shareholders
(Page)
------------------
<S> <C>
Independent Auditors' Report 53
Consolidated Balance Sheets as of December 31, 34
1998 and 1997
Consolidated Statements of Operations for the years 35
ended December 31, 1998, 1997 and 1996
Consolidated Statements of Changes in 36
Shareholders' Equity for the years ended December
31, 1998, 1997 and 1996
Consolidated Statements of Cash Flows for the years 37
ended December 31, 1998, 1997 and 1996
Consolidated Statements of Comprehensive Income 38
for the years ended December 31, 1998, 1997 and
1996
Notes to the Consolidated Financial Statements for
the years ended December 31, 1998, 1997 and 1996 39
</TABLE>
In addition, "Management's Discussion and Analysis of Financial Condition
and Results of Operations begins on page 25 of the 1998 Annual Report to
Shareholders.
2. FINANCIAL STATEMENT SCHEDULES:
The following Financial Statement Schedules are filed as part of this
Report.
Schedule I - Summary Of Investments Other Than Investments In Related Parties
(Dollars in thousands)
<TABLE>
<CAPTION>
Amount
Amortized Shown in
Type of investment Cost Fair Value Balance Sheet
- ------------------------------------------------------- --------- ---------- -------------
<S> <C> <C> <C>
Fixed maturities - available for sale
Corporate securities $138,447 $138,727 $138,727
U.S. Treasury securities 31,887 31,698 31,698
Mortgage-backed securities/Asset-backed securities 9,230 9,232 9,232
Obligations of states and political subdivisions 24,231 24,647 24,647
Foreign currency debt securities 7,794 8,083 8,083
-------- -------- --------
Total fixed maturities - available for sale 211,589 212,387 212,387
Strategic investments 5,917 5,917 5,917
Cash and cash equivalents 16,942 16,942 16,492
-------- -------- --------
Total investments and cash $234,448 $235,246 $235,246
======== ======== ========
</TABLE>
16
<PAGE> 17
Schedule III - Supplementary Insurance Information
(Dollars in thousands)
<TABLE>
<CAPTION>
Unpaid
Deferred Losses and Net Net
Acquisition Loss Unearned Premiums Investment
Segment Costs Expenses Premiums Earned Income
- -------------------- ------------ ------------ ------------ ------------ -------------
<S> <C> <C> <C> <C> <C>
December 31, 1998
Total $37,625 $44,379 $111,884 $98,841 $12,930
============ ============ ============ ============ =============
<CAPTION>
Paid Amortization
Losses of Deferred Other Net
and Loss Acquisition Operating Premiums
Segment Expenses Costs Expenses Written
- -------------------- ----------- -------------- ----------- -----------
<S> <C> <C> <C> <C>
December 31, 1998
Total $27,592 $26,714 $11,965 $25,392
=========== ============== =========== ===========
</TABLE>
Schedule IV - Reinsurance
(Dollars in thousands)
<TABLE>
<CAPTION>
Percentage of
Direct Ceded to Assumed Amount
Gross Other from Other Net Assumed to Net
Amount Companies Companies Amount Amount
----------------- --------------- ----------------- --------------- -------------------
<S> <C> <C> <C> <C> <C>
December 31, 1998
Total premiums earned $-- $2,144 $100,985 $98,841 102%
================= =============== ================= =============== ===================
</TABLE>
The report of the Company's independent auditors with respect to the
above-listed Financial Statement Schedules is set forth in Exhibit 24.1(a) of
this report.
All other schedules are omitted because they are either inapplicable for
the required information or are presented in the Consolidated Financial
Statements of the Company or the Notes thereto, which are incorporated by
reference in this Annual Report on Form 10-K.
3. EXHIBITS:
2.1* Share Exchange Agreement between ESG Re Limited and
European Specialty Group (United Kingdom) Limited, dated
as of November 13, 1997
2.2* Share Exchange Agreement between the shareholders of
European Specialty Group Holding AG and European
Specialty Group (United Kingdom) Limited, dated as of
November 13, 1997
3.1* Memorandum of Association
3.2* Bye-Laws
4.1* Specimen Common Share certificate
4.2* Form of Class A Warrant
4.3* Form of Class B Warrant
10.1* Form of Subscription Agreement, between ESG Re Limited
and certain Direct Purchasers, dated as of September 30,
1997
10.2* Employment Agreement between European Specialty Group
(United Kingdom) Limited, ESG Re Limited and Wolfgang M.
Wand, dated as of December 1, 1997
10.3* Employment Agreement between ESG Re Limited and Steven
H. Debrovner, dated as of December 1, 1997
10.4* Employment Agreement between European Specialty Group
Holding AG and Gerhard Jurk, dated as of December 1,
1997
10.5* Employment Agreement between European Specialty (North
America) Limited and Renate M. Nellich, dated as of
December 1, 1997
10.6* Investment Advisory Agreement between ESG Re Limited and
Head Asset Management L.L.C.,
17
<PAGE> 18
dated as of December 1, 1997
10.7* Investment Advisory Agreement between European Specialty
Ruckversicherung AG and Head Asset Management L.L.C.,
dated as of December 1, 1997
10.8* Form of Registration Rights Agreement between ESG Re
Limited and the Direct Purchasers named therein
10.9** Form of Non-Management Directors' Compensation and
Option Plan, approved on December 3, 1997 between ESG Re
Limited and non-employee director optionees
10.10** Form of 1997 Stock Option Plan, approved on December 3,
1997 between ESG Re Limited and certain optionees
13.1 1998 Annual Report to Shareholders
22.1* Subsidiaries of the Registrant
24.1(b) Consent of Deloitte & Touche
27.1 Financial Data Schedule
- ----------
* Incorporated by reference to Amendment No. 1 to the Registration Statement
on Form F-1 of the Company, as filed with the Securities and Exchange
Commission on December 9, 1997 (registration No. 333-40341). The Consent
by the Company's independent auditors to incorporate by reference is set
forth in Exhibit 24.1(b) of this report.
** Incorporated by reference to Exhibit 10.9 of the Company's Form 10-K for
the year ended December 31, 1997, filed with the Securities and Exchange
Commission on March 31, 1998.
(b) Reports on Form 8-K. On March 10, 1998, the Company filed a report
on Form 8-K. There were no other reports on Form 8-K filed during
the period from January 1, 1998, to December 31, 1998.
18
<PAGE> 19
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, thereunto authorized,
on March 30, 1999. This report dealt with changes to the size and membership of
the Board of Directors and the resulting cessation of qualification as a foreign
private issuer pursuant to Rule 3b-4 under the Securities Act of 1934 and
subsequent assumption of status of domestic private issuer.
ESG RE LIMITED
By: /s/ JOAN H. DILLARD
------------------------------
Name: Joan H. Dillard
Title: Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Company has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ WOLFGANG M. WAND
- ------------------------------
Wolfgang M. Wand Managing Director and March 30, 1999
Chief Executive Officer
and Director
/s/ STEVEN H. DEBROVNER
- ------------------------------
Steven H. Debrovner Chief Underwriting and March 30, 1999
Marketing Officer
and Director
/s/JOAN H. DILLARD
- ------------------------------
Joan H. Dillard Chief Financial Officer March 30, 1999
/s/ JOHN C HEAD III
- ------------------------------
John C Head III Chairman of the Board March 30, 1999
/s/ KENNETH P. MORSE
- ------------------------------
Kenneth P. Morse Director March 30, 1999
/s/ DAVID L. NEWKIRK
- ------------------------------
David L. Newkirk Director March 30, 1999
/s/ WILLIAM J. POUTSIAKA
- ------------------------------
William J. Poutsiaka Director March 30, 1999
/s/ EDWARD A. TILLY
- ------------------------------
Edward A. Tilly Director March 30, 1999
</TABLE>
19
<PAGE> 1
INTELLIGENT
REINSURANCE
ESG RE LIMITED
ANNUAL
REPORT 1998
Intelligent
Reinsurance
ESGCM-AR-99
LIVING LONGER, LIVING BETTER.
With an aging and increasingly affluent population, the demand for retirement
planning has never been greater. Social systems may become less able to provide
for their older citizens, creating a growing demand for products that allow
individuals to protect themselves and their standard of living. ESG Re is
committed to the delivery of innovative products and services in our field of
expertise-the reinsurance of people, their health and well-being-thus enhancing
the lifestyle of this important customer group.
3 Financial Highlights
4 Letters to Shareholders
8 Results for 1998
10 Operating Review
24 Selected Consolidated
Financial Data
25 Management's Discussion and
Analysis of Financial Condition
and Results of Operations
34 Consolidated Financial Statements
53 Independent Auditors' Report
54 Corporate Directory
56 Shareholder Information
<PAGE> 2
COMPANY PROFILE
ESG Re Limited is a specialty reinsurance company providing accident, health,
life, disability and related special risk reinsurance to the insurance industry
on a worldwide basis. With four operating risk carriers located in Bermuda,
Ireland and Germany, and offices in 10 countries, ESG Re underwrites risks in
more than 50 nations. Focusing on the growing markets of health, accident, and
disability, we specialize in applying "Intelligent Reinsurance," an analytical
and innovative approach to product development and risk management. Our mission
is to be the leading international underwriter in these markets, dedicated to
providing risk solutions to the reinsurance challenges of the world's growing
and emerging markets. We commit ourselves to provide tailor-made solutions for
our clients, to honor our obligations to our ceding companies, and to
consistently generate underwriting profit for our shareholders. We are aware of
the role we assume as professional reinsurers when leading and supporting the
trends that create more efficient welfare systems for the public.
<PAGE> 3
FINANCIAL HIGHLIGHTS
ESG Re began writing reinsurance for its own account in December 1997. Results
for 1997, when the Company functioned both as a reinsurer and reinsurance
management company, are not comparable.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, 1998 1997
- --------------------------------------------------------------------------------
<S> <C> <C>
U.S. dollars in thousands, except per share data
CONSOLIDATED OPERATING DATA
Gross managed premiums $224,204 $100,000
Net premiums written 195,578 25,392
Net premiums earned 98,841 13,411
Investment income 12,930 598
Total revenues 115,827 17,839
Losses and loss expenses 61,364 7,449
Acquisition costs 26,714 4,693
Class B Warrants expense -- 3,626
Administrative expenses 11,965 7,736
Total expenses 100,043 23,504
Net underwriting income 10,763 1,269
Loss ratio 62.1% 55.5%
Acquisition cost ratio 27.0% 35.0%
Loss and acquisition cost ratio 89.1% 90.5%
CONSOLIDATED BALANCE SHEET DATA
Investments and cash $235,246 $236,976
Total assets 466,373 283,553
Unpaid losses and loss expenses 44,379 7,846
Total shareholders' equity 244,841 234,375
Book value per share 17.58 16.83
Common stock Price range
High $ 28.75 $ 23.88(1)
Low $ 12.75 $ 21.50(1)
- --------------------------------------------------------------------------------
</TABLE>
(1) 1997 stock prices are for the period from December 12, 1997, the date of
the initial public offering, to December 31, 1997. The initial public
offering price was $20.00 per share.
3
<PAGE> 4
CHAIRMAN'S
LETTER
At the end of 1997, we identified four specific objectives for ESG Re in 1998:
o To expand its business by geographic region, by source and by producer;
o To recruit, train and motivate the very best people;
o To underwrite profitable business; and
o To provide quality solutions to customer problems and to operate with the
highest standards.
In 1999, ESG Re will continue to pursue these principal objectives and to
expand on what has already been accomplished.
ESG Re now has reinsurance relationships with over 200 insurance companies
in 57 countries. In 1998, ESG Re developed and strengthened its relationships
with the world's major reinsurance intermediaries as well as with specialist
brokers that are important in ESG Re's lines of business. Further expansion of
our list of clients and brokers is envisaged in order to meet our goals for
business development.
One of ESG Re's most important competitive advantages is the quality and
motivation of its people. In 1998, we substantially expanded the ESG Re team of
professionals. They have made significant contributions to the growth of our
business and to the quality of our administration and systems. As ESG Re builds
for the future, we must continue to recruit, train and motivate the best people
in the industry. This activity is not without its cost, as expenses will be
incurred before new professionals can contribute to revenues and profits.
However, investment in our people is critical if ESG Re is to meet the high
expectations that we all share.
In 1998, ESG Re underwrote approximately $200 million of gross written
premiums. This business was profitable as written, with a combined ratio of
98.0%. According to generally accepted accounting principles, however, the
majority of this business will be classified as earned premium in 1999.
Consequently, most of the positive effect on earnings and profits will occur in
1999, rather than during the year in which the business was written. This will
be a continuing pattern as ESG Re continues to grow rapidly its book of
business. However, as long as the business is underwritten profitably,
shareholder value will be created, regardless of the timing of the recognition
of earned premiums.
As we continue to expand our company, meeting the needs of our customers
and operating with the highest professional and ethical standards will continue
to be the cornerstones of our operating strategy.
In 1999, we will continue to build on our accomplishments and to strive for
industry leadership in our specialty field of reinsurance expertise.
John C Head III, Chairman of the Board
<PAGE> 5
CHIEF
EXECUTIVE
OFFICER'S
LETTER
Nineteen ninety-eight marks the first full year of operations for ESG Re Limited
as a publicly traded company, following the successful transition from a leading
reinsurance management company into a globally-trading professional reinsurance
group specializing in the fields of health, accident, disability, life and
related special risk insurance.
Results achieved in 1998 evidence the success of ESG Re's strategic
positioning. We increased our premium volume by over 100% in a general market
environment where the industry grew at a rate of 3%. More importantly, our 1998
loss and acquisition ratio of 89.1% indicates that we achieved this growth and
leadership position while maintaining our stringent underwriting standards and
our focus on profitability.
It is ESG Re's trademark, and our unique concept of "Intelligent
Reinsurance," coupled with the wide-ranging relationship network of
long-standing industry experts, the underwriting skills and the dedicated
customer focus of our employees, which make ESG Re a desired partner of our
customers, the ceding companies and the professional intermediaries.
<PAGE> 6
"INTELLIGENT REINSURANCE" VERSUS CAPACITY
The global reinsurance market has undergone rapid change in recent years. These
changes have resulted in mergers among many well-known reinsurance providers,
and the disappearance, or loss of independence, of significant capacities.
Medium-sized reinsurers are finding it difficult to survive or to grow
profitably due to the soft pricing environment; ceding companies have redefined
their reinsurance purchasing strategy in favor of non-proportional coverage; and
the flight to increased security continues. In addition, the current low
interest rate environment cannot support unsatisfactory underwriting results.
These paradigm shifts and rapid changes also represent opportunities. As
the leading globally-trading expert in our lines of business - the reinsurance
of people, their health, life and well-being - ESG Re helps the ceding customer
to grow its portfolio with product design, coverage enhancements and marketing
techniques, and to improve profitability by providing loss prevention and claims
control measurements. ESG Re has provided a new definition of the
often-neglected principle of insurer-reinsurer relationships: To Share the
Fortune. The reinsurance cession becomes our share of the arrangement. By
improving our customers' profits, we have been able to experience outstanding
growth and very satisfactory technical underwriting results.
GLOBAL DIVERSIFICATION
Our portfolio is divided into three parts: approximately one-third of our
premium comes from Europe, our traditional stronghold; one-third from North
America; and one-third from the highly prospective growth markets of Latin
America, the Far East and selected markets in Eastern Europe. ESG Re values and
supports the local culture by combining global experience with the regional
expertise of our offices located around the world.
Investment in highly skilled professionals, and corresponding
infrastructure, is a prerequisite for building long-term value as a leading
specialist reinsurer. The major developments and investments of the last year
have significantly contributed to ESG Re's current and future value:
o The opening of European Specialty (North America) Limited, our
Toronto-based operation, in the fall of 1997, represented a substantial
investment for ESG Re. The Toronto office commenced underwriting in North
America on January 1, 1998, and has produced solid results, both in quality
and quantity of business.
o We opened our Sydney operation and an additional branch in Hong Kong, to
cover the Asia/ Pacific Rim. Again, early indications are very encouraging
and we expect the results to come to full fruition in 1999.
o Our U.K.-based underwriting team was strengthened to provide specialty
underwriting services in the London market.
o Accent Europe Insurance Company Limited, a direct writing company in
Ireland, was formed to offer health and accident products and services on a
pan-European basis.
o We opened a subsidiary in Miami to serve the reinsurance needs of our
growing Latin American customer base, an investment that has already
contributed strongly to our results in the second half of 1998.
o A Shared Services Center was opened in Dublin, Ireland, to concentrate our
global accounting, administration and reinsurance processing.
o ESG Re acquired a majority interest in our affiliate company, SportSecure,
positioning this entity as the center for special risk underwriting in the
rapidly growing field of sports and entertainment insurance.
<PAGE> 7
OUTLOOK
ESG Re is well positioned in the rapidly growing fields of health, accident,
disability, life and related special risk reinsurance. Our market approach -
"Intelligent Reinsurance" - gives us the ability to provide unique solutions to
our partners and manifests our position as sole or lead reinsurer to ceding
companies and professional intermediaries on a global basis.
We base our growth outlook on two fundamental trends:
o a continuing global shift from public welfare to the private sector; and
o increasing insurance demands of a growing aging, affluent population.
I am convinced that ESG Re is in a unique position to lead these trends of
social welfare privatization. We will utilize our in-depth knowledge of local
requirements, our understanding of underlying social security concerns and
legislation, and our expertise in the active utilization of cost reduction and
control techniques as practiced by our North American operations on these newly
created and untapped reinsurance opportunities. Late in 1998 we undertook an
initiative to introduce certain "managed care" concepts to Europe --
particularly Germany and Spain -- and Latin America. The results seen in certain
Latin American markets are very encouraging and, although progress might be
slower in Continental Europe than in less regulated markets, the opportunities
are fascinating and ultimately will be of substantial benefit to ESG Re.
We have selected portraits of elderly people for this annual report because
the growing insurance demand of the aging represents widely untapped potential.
One of the demanding projects ESG Re will be addressing in 1999 will be the
exploration of opportunities presented by this affluent segment of the
international population. We continue to pioneer the creation of sizable new
markets that have not been adversely affected by excessive competition or soft
pricing.
Aside from these opportunities in the managed care and aging market
spheres, I am very encouraged by the early indications of the 1999 renewal
season, and ESG Re's enhanced recognition as a desired lead reinsurer. Many
prospects for which we successfully laid the groundwork in 1998 are now coming
to fruition. Therefore, I am convinced that we will experience another year of
substantial growth, well above industry standards, which will further enhance
profitability. We will continue to focus upon the traditional short-tail lines
of business, thereby providing a transparency to our financial position that
benefits both our shareholders and customers.
SPECIAL THANKS
The past year required strong dedication and extremely hard work from all of our
employees around the globe. It also posed the challenge to integrate new teams
of multicultural entrepreneurial leaders into the group. This challenge was met
thanks to the commitment of our management and staff to demonstrate the
flexibility and mobility required of a truly global company.
We thank our shareholders, customers, ceding companies and the
professional intermediaries for your vote of confidence in ESG Re.
Wolfgang M. Wand,
Managing Director and
Chief Executive Officer
<PAGE> 8
RESULTS FOR 1998
In December 1997 the Company raised over $250 million in capital through a
private placement and an initial public offering, completing its transition from
an underwriting manager to a specialty reinsurer. Therefore, the underwriting
data for 1997 does not offer a meaningful comparison with 1998 results.
For the year ending December 31, 1998 the Company reported net income of
$14.5 million, or $1.04 net earnings per share.
In 1998, the Company more than doubled its portfolio of managed premium to
$224.2 million, of which $24.3 million was co-reinsured with strategically
aligned reinsurance partners, resulting in $199.9 million of gross premiums
written for the period. In its former function as a managing agent, the Company
underwrote, on behalf of various reinsurers, approximately $100 million of gross
premiums in 1997.
Our exceptional growth was achieved within the parameters of our targeted
product and geographic mix across Europe, North America and the emerging
markets. The Company generated in excess of $186 million in new business in
1998.
Total revenues for the year were $115.8 million, consisting of net premiums
earned of $98.8 million, with net investment income of $12.9 million, realized
investment gains of $2.2 million and management fee revenue of $1.9 million. ESG
Re's loss and acquisition cost ratio was 89.1% in 1998, comparing favorably to
90.5% in the previous year.
<PAGE> 9
OPERATING REVIEW
INTELLIGENT REINSURANCE -
MORE THAN CAPACITY
ESG Re's business philosophy is centered on providing client-oriented solutions,
not just reinsurance capacity. It is under the trademark of "Intelligent
Reinsurance" that ESG Re conducts all of its underwriting activities, by
offering a single source for a range of value-added services, including loss
prevention, data management, product development and marketing support.
LOSS PREVENTION Normally, a reinsurer is not actively involved in claims
handling and it is the responsibility of the ceding client to adjust the
original losses and settle claims made by its direct insureds. Although some of
the business managed by ESG Re operates in this manner, our approach in
healthcare differs from other reinsurers in that we actively seek to reduce
claims exposure by utilizing proven "managed care" techniques while the
reinsurance policies are in force.
Working with ESG Re, one of the leading general insurers in the Middle East
has been able to create a range of health products and services that offer the
local market access to medical facilities both at home and abroad. ESG Re has
provided its client with extensive loss prevention tools, including gatekeeping
systems that afford direct control of treatment costs and help to prevent
over-utilization. Also, by assisting in the recruitment and training of staff,
ESG Re has helped the insurer to create the necessary competitive advantage to
take a dominant position in its country's developing health insurance market.
DATA MANAGEMENT Sharing information with our clients offers a highly
analytical and proactive approach to risk management and offers more creative
solutions to their underwriting needs. Centralized data capture and monitoring
systems, combined with our technical underwriting expertise, ensure maximum
control of all risks at all times. No matter where a policy may originate or
whatever medical treatment is undertaken, our extensive knowledge of local
facilities and services enables ceding companies to manage their business
better.
ESG Re's technology has assisted another client with a growing portfolio of
multinational business to clearly identify the sources and composition of the
insured population and to manage risk selection and overall exposure better.
PRODUCT DEVELOPMENT Working in close relationship with our customers, we
design and launch new products and services that enable ceding companies not
only to remain competitive in their traditional markets, but also to enter new
ones. From credit card enhancement programs to sophisticated multinational
employee benefit plans, ESG Re's global experience and creative underwriting
techniques provide ceding companies with an alternative approach to product
development. In the former Soviet State of Georgia, ESG Re has helped to
establish the first locally-managed insurance company to be run along Western
business standards, supplying a range of innovative products and services,
extensive management and training support, technical expertise and capital
funding.
MARKETING SUPPORT By applying a detailed knowledge and understanding of
local markets and their cultural needs and demands, ESG Re is able to assist
with corporate communications, sales techniques and product marketing. In the
Far East, ESG Re's direct marketing expertise and management has enabled a major
international financial institution to create and successfully tele-market a
range of personal insurance products designed for their account holders.
FINANCIAL STRENGTH The ESG Re group of companies offers high-quality
financial security to our ceding clients and business partners. ESG Re has a
Standard & Poor's rating of A- and total capitalization of over $240 million at
December 31, 1998.
"Intelligent Reinsurance" is more than capacity. ESG Re delivers the
expertise, products, analysis and service that create a true and lasting
partnership with our clients -- a partnership that delivers added value and
enhances the success of their business.
ESG RE'S GLOBAL DIVERSITY
ESG Re provides "Intelligent Reinsurance" on a global basis. Our offices are
strategically located in some of the world's most important business centers. An
established global infrastructure with coordination among offices enables ESG Re
to respond quickly and effectively with the appropriate products, programs and
services necessary to capitalize on market opportunities. Last year ESG Re
managed risks in more than 50 countries worldwide and, with the introduction of
new products tailored to meet the needs of our clients, we continually enhance
our global presence.
MAJOR MARKETS
ESG Re is a specialist provider of reinsurance solutions focused on those
developed and emerging markets that allow for a satisfactory volume and growth
potential while providing attractive underwriting margins. By taking advantage
of the Company's global structure and its experienced management, we are able to
"import" the best underwriting and management techniques from around the world
to help tailor solutions for our customers' needs.
EUROPE The deregulated European market is leading the trend toward
globalization, and ESG Re has taken a leadership position in the creation of
alternative concepts and distribution methods in these established and more
saturated markets. The Company generated $62.0 million of managed premium in
Europe in 1998, an increase of 18.5% over the prior year. We attribute our
success in this market to the strength of our long-standing relationships and
the pursuit of innovative product opportunities.
In Germany, we are introducing progressive technologies that will open up
new and more streamlined distribution channels. Coupled with the growing need
for healthcare management techniques as the social welfare system adjusts, ESG
Re has a distinct advantage as a specialized player. Able to respond quickly to
market needs, we have already secured exclusivity in the German market for an
EKG and Diabetic Telemedicine technology.
ESG Re's "Intelligent Reinsurance" is the concept behind the recent
formation of a healthcare association, COMED Interessengemeinschaft der
Krankenversicherten e.V. ("COMED"), within the German market. COMED will provide
sought-after services, such as physician referrals, a medical information
hotline, second opinion services, and disease management advisors, with a target
market of the estimated 70 million people within the German public healthcare
system.
10
<PAGE> 10
In Spain, ESG Re has created a unique medical program that provides a
Second Opinion product to complement the services provided by the State
healthcare system.
EMERGING EUROPE For the past five years, ESG Re has assumed a pioneering
role across the emerging markets of Eastern Europe and the former Soviet Union.
The changing political, economic and demographic landscape of the region offers
opportunities for the application of the "Intelligent Reinsurance" concept and
our unique support services to ceding companies. In the wake of political and
financial turmoil, governments are imposing more stringent capital requirements
on local insurers, leading to the need for reinsurance to support current
business volume as well as future growth and development. Our ongoing support is
aimed at fostering the growth of a locally autonomous insurance industry.
During 1998, ESG Re forged a partnership with IMEDI L International
Insurance Company Limited, one of Georgia's leading insurance companies, to lend
our experience in Western insurance practices and to introduce basic products to
a growing customer base as their insurance needs emerge. In turn, this
partnership enables ESG Re to test product offerings that may be exported into
the surrounding countries of the Caucasus region. The provision of healthcare
and pension coverages, following shortfalls in state funding, is becoming a risk
line that local authorities are anxious to develop with reliable partners.
LONDON INTERNATIONAL MARKET Despite continuing overcapacity and price
competition in the London market, ESG Re distinguishes itself through its
reputation for innovation. With a growing acceptance of the Company's financial
strength and management expertise, and the creation of a specialist unit in
London, we are well positioned in the international accident and health market.
ESG Re offers facultative specialty lines mainly as a lead line underwriter of
London market brokers' programs.
Managed premium of $35.6 million was written in 1998. ESG Re's specialist
knowledge and global approach have attracted a wide audience and increasing
recognition in the London market. The strength of established relationships
provides ESG Re the opportunity to access attractive pieces of business, to
apply profit-oriented underwriting standards, and to build a long-term portfolio
generating above-average returns.
<PAGE> 11
NORTH AMERICA With annual premiums of more than $5 billion, North America
is the world's largest health reinsurance marketplace. During the early 1990s,
price competition was driven by new market entrants who put increasing pressure
on terms and profitability. In the last 24 months, however, several companies
have reduced their writings or exited the market entirely, resulting in
shrinking capacity and hardening of market terms and conditions. ESG Re has been
able to take advantage of these market changes by adopting a strategy
emphasizing risk analysis, active control, and diligent management. The Company
has capitalized on its existing business relationships and profited from key
opportunities, while fostering a "partnership" philosophy where ESG Re and the
client are able to work closely together to help minimize risk exposure.
ESG Re's newly established operation in Toronto generated $89.2 million in
managed premium in its first year, representing 39.8% of 1998 production. In
North America, the majority of our business is sourced directly, although 47.0%
is written through brokers and intermediaries. Medical expense programs are our
primary product offering, with 39.3% written on a proportional basis and 60.7%
on a nonproportional or stop loss basis.
ESG Re is committed to assuming a leadership position in the North American
market in the areas of both profitability and quality, and plans to export the
concept of "managed care" to Europe and other markets. We are actively exploring
and developing new health insurance techniques, products and services. We intend
to pursue diversification of our product lines in North America, emphasizing
personal accident and life business. In the past year, ESG Re has developed name
recognition and has become a respected participant in the North American
marketplace, where we are now well positioned for future growth.
LATIN AMERICA ESG Re currently offers an extensive range of medical,
personal accident, credit and life reinsurance programs to ceding companies
throughout Latin America. A growing area of emphasis for ESG Re, Latin America
generated $33.4 million of managed premium in 1998, growing from $19.2 million
in 1997. ESG Re's strategy in the region is to combine capacity with controlled
marketing and administration to secure profitability while pursuing a meaningful
share of the market. In conjunction with a major financial services and
insurance group, the Company has concentrated on developing a portfolio of
individual and group medical plans that allows ESG Re to be directly involved in
setting the pricing and underwriting parameters and in monitoring the claims
handling practices.
In various Latin American countries, ESG Re has established Third Party
Administration faciliities ("TPA's") in conjunction with our strategic partners.
Access to information through these TPA's enables us to calculate more accurate
attachment points and to refine pricing. Regional claims management staff also
interact directly with the local adjusters to coordinate managed care service.
ESG Re is actively writing occupational injury accounts in Colombia and
Peru, where the need for high limit accident benefits has been created by the
privatization of the workers' compensation structures, previously handled by
government controlled social security monopolies. In Latin America, ESG Re's
long-standing relationships, dedication and partnership philosophy give us a
clear competitive advantage.
ASIA/PACIFIC The economic crisis in Asia has seriously affected the growth
and profit projections of most insurance and reinsurance companies in the
region. Consumer and business confidence is low due to the economic downturn,
with pressure mounting on the individual social security programs. There will be
significant opportunity for ESG Re in Asia as medical programs of various
countries privatize over the next 5 to 10 years.
The boom in the Asian economies over the past 10 to 20 years has seen
insurance companies rapidly expand using traditional insurance agents as the
principal means to distribute life and general products. The most successful
companies have been those that were able to build larger agency distribution
systems. Now, companies must streamline their distribution to protect profit
margins. The successful companies will be those that target new means to
distribute or develop new products made to suit the new, emerging economic
environment.
Currently, companies are racing to establish alternative distribution
channels to replace or to compete with the expensive, career-agent structure
prevalent in the region. These companies have witnessed the rapid growth of
direct marketing programs in the United States and Europe and are attempting to
build competitive strength in this channel. Many local insurance companies are
captives of conglomerates that also own banks and credit card companies, giving
them a base of potential insurance customers.
<PAGE> 12
ESG Re's strategy and competitive strength in Asia centers on alternative
distribution, direct marketing and telemarketing. During 1998, ESG Re built a
platform to offer direct marketing and management services. Local insurance
companies market under their own name, building brand recognition and their
reputation. ESG Re is remunerated for its services by receiving a quota share
cession of all business generated.
The region might continue to see turbulent times in the next few years. ESG
Re has invested in the infrastructure and talent necessary to capitalize on the
huge market opportunities that will emerge as the cycle improves in Asia. ESG
Re's "Intelligent Reinsurance" approach, adding value to ceding companies by
providing expertise and service in return for reinsurance, will be well received
and supported in Asia.
MIDDLE EAST/AFRICA In the Middle East, where an increasing number of
governments are now actively looking to transfer the responsibility of
healthcare from the state to the private sector, ESG Re applies its specialist
knowledge and "Intelligent Reinsurance" concepts. In what can be viewed as a
difficult sector of the market, careful selection of "partners" from across the
region has allowed the Company to control the types of risks being written and
the claims settlement process. Services provided include the creation of
preferred provider networks and the establishment of gatekeeping systems to
control utilization and to avoid duplication of treatment. Health conditions of
a serious nature are coordinated between the local ceding customers and ESG Re's
London-based specialist healthcare division, European Specialty Insurance
Management Services ("ESIMS").
MAJOR LINES OF BUSINESS
MEDICAL EXPENSES As a specialist underwriter focusing on markets requiring
dedicated know-how, ESG Re's extensive knowledge ensures that ongoing actuarial
analysis, timely and efficient information systems, accurate risk evaluation and
modern administrative methods act as a cornerstone to both initial and ongoing
profitability. Medical expense coverage remains ESG Re's leading product line,
with $132.1 in managed premium in 1998, representing 58.9% of the total
portfolio. Proportional reinsurance programs represent 58.4% of our medical
book, with 41.6% written on a non-proportional specific or stop loss basis.
o Acceptance limit - $5 million lifetime limit per person
o No accumulation limit
PERSONAL ACCIDENT Our extensive experience has enabled ESG Re to
underwrite both traditional and non-traditional risks through an innovative
approach to risk acceptance and to create solutions to clients' personal
accident and disability requirements. A dedicated know-how in the field of
occupational injury has established ESG Re as a desired lead reinsurer in this
demanding line within the personal accident arena. With 1998 managed premium of
$59.4 million and very satisfactory underwriting results, personal accident
lines have delivered consistent growth and profitability to the Company.
o Acceptance limit - $5 million per person
o $30 million known accumulation
CREDIT/LIFE AND DISABILITY Providing group and substandard life capacity
and pricing services, as well as credit/life, disability and unemployment
insurance, ESG Re has built up considerable experience both in the North
American and European markets. Managed premium from these product lines totaled
$27.1 million in 1998.
o Acceptance limit - $5 million any one person
o No accumulation limit
SPECIAL RISK Covering a wide range of insurance with unique risk
characteristics such as professional sports, contingency, non-appearance,
cancellation and abandonment, ESG Re's sports and entertainment business is
managed by its affiliate company, SportSecure, one of the industry's leading
underwriters in the specialist market. In 1998, Special Risk reinsurance totaled
$5.6 million. As a recognized leader in this particular segment, we are capable
of structuring and arranging even the largest event coverages, such as the 2002
Soccer World Cup, with a record sum insured exceeding 2 billion Swiss francs,
o Acceptance limit - $5 million any one person
o Up to $10 million any one event or series of events
ESG Re Limited conducts its business through four operating companies that
are risk carriers: European Specialty Reinsurance (Bermuda) Limited ("ES
Bermuda"), a wholly owned subsidiary of ESG Re Limited; European Specialty
Reinsurance (Ireland) Limited ("ES Ireland"), a wholly owned subsidiary of ES
Bermuda; European Specialty Ruckversicherung AG ("ES Germany"), a wholly owned
subsidiary of European Specialty Group Holding AG; and Accent Europe Insurance
Company Limited ("Accent"), a wholly owned subsidiary of ES Ireland. Supporting
underwriting services are provided by the group's subsidiaries in London,
Toronto, Miami and Sydney, with further market support from branches and
representative offices in Hong Kong and Moscow. With underwriting profits
accruing primarily in Bermuda and Ireland, the Company benefits from the
favorable tax environments in those jurisdictions.
<TABLE>
<CAPTION>
CAPITALIZATION OF ESG'S RISK CARRIERS AT DECEMBER 31, 1998
<S> <C> <C> <C> <C> <C> <C> <C>
ES Bermuda $140 million ES Ireland $101 million Accent $15 million ES Germany $12 million
MOSCOW
DUBLIN
HAMBURG
BERLIN
LONDON
TORONTO
BERMUDA
MIAMI
HONG KONG
SYDNEY
</TABLE>
<PAGE> 13
ESG RE IMPORTS THE BEST UNDERWRITING AND
MANAGEMENT TECHNIQUES FROM AROUND THE WORLD TO
HELP TAILOR SOLUTIONS FOR OUR CUSTOMERS' NEEDS.
1998 GROSS MANAGED
PREMIUM BY OFFICE
a. North America-39.8%
b. Europe-27.7%
c. London International-15.9%
d. Latin America-14.8%
e. Rest of World-1.8%
<PAGE> 14
ESG RE'S BUSINESS PHILOSOPHY
IS CENTERED ON PROVIDING CLIENT-ORIENTED SOLUTIONS, NOT
JUST REINSURANCE CAPACITY.
1998 GROSS MANAGED
PREMIUM DISTRIBUTION
a. Medical Expense-58.9%
b. Personal Accident-26.5%
c. Credit/Life and Disability-12.1%
d. Special Risk-2.5%
<PAGE> 15
ORGANIZATION OF THE COMPANY
ESG Re Limited
("ESG Re" or "the Company")
European Specialty
Reinsurance (Bermuda)
Limited ("ES Bermuda")
European Specialty
Group (United Kingdom)
Limited ("ESGUK")
European Specialty
Reinsurance (Ireland)
Limited ("ES Ireland")
European Specialty
North America Limited
("ESNorth America")
European Specialty Group
Holding AG
("ESG Germany")
Other Operating
Subsidiaries
Accent Europe Insurance Company Limited
("Accent")
European Specialty
Ruckversicherung AG
("ES Germany")
Other Operating
Subsidiaries
<PAGE> 16
ESGRE LIMITED
SELECTED CONSOLIDATED FINANCIAL DATA
The following table sets forth the selected consolidated financial data for ESG
Re Limited and subsidiaries. The financial statements included herein represent
the financial performance and results of the Company as a reinsurer for the year
ended December 31, 1998, as a reinsurer and reinsurance management company for
the year ended December 31, 1997 and as a reinsurance management company only
for the years prior to 1997. The consolidated statement of operations data for
the years ended December 31, 1998, 1997, 1996 and 1995, and the consolidated
balance sheet data as of December 31, 1998, 1997, 1996, 1995 and 1994, have been
derived from the Company's audited Consolidated Financial Statements. The
consolidated statement of operations data for the year ended December 31, 1994
has been derived from the Company's unaudited financial statements and, in the
opinion of management, reflects all adjustments necessary for a fair
presentation of the results of operations. The data should be read in
conjunction with the Company's Consolidated Financial Statements, related notes,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and other financial information appearing elsewhere herein.
<TABLE>
<CAPTION>
Years Ended December 31, 1998 1997(1) 1996 1995 1994
==========================================================================================================
U.S. dollars in thousands except per share data
<S> <C> <C> <C> <C> <C>
STATEMENT OF
OPERATIONS DATA:
Net premiums earned(1) $ 98,841 $ 13,411 $ -- $ -- $ --
Management fee revenue 1,894 3,830 3,869 4,515 3,309
Net investment income 12,930 598 186 -- --
Total revenues 115,827 17,839 4,055 4,665 3,351
Total expenses
(excludes tax benefits/expenses) 100,043 23,504 4,062 4,221 3,313
Net income (loss) 14,522 (5,096) (163) 146 (6)
Basic net income (loss) per share(2) 1.04 (4.11) (1.38) -- --
Diluted net income (loss) per share(2) 1.03 (4.11) (1.38) -- --
=========== ========== =========== ======= ========
</TABLE>
<TABLE>
<CAPTION>
Years Ended December 31, 1998 1997(1) 1996 1995 1994
==========================================================================================================
<S> <C> <C> <C> <C> <C>
U.S. dollars in thousands except per share data
BALANCE SHEET DATA:
Total investments and cash $235,246 $236,976 $ 15 $ 33 $ 21
Total assets 466,373 283,553 7,446 2,683 2,881
Unpaid loss and loss expenses 44,379 7,846 -- -- --
Total shareholders' equity (deficit) 244,841 234,375 (489) (152) (90)
======== ======== ======== ======== ========
</TABLE>
The Company declared a dividend on February 25, 1999 of $0.08 per common share
to be paid on March 22, 1999 to the shareholders of record on March 15, 1999.
(1) In 1997, the Company began operations as a reinsurance company.
(2) The 1996 per share data has been calculated on a recapitalized basis.
Earnings per share data has not been calculated prior to 1996 as no shares
were outstanding.
ESGRE LIMITED
24
<PAGE> 17
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following is a discussion and analysis of the financial condition, results
of operations, liquidity and capital resources of ESG Re Limited and its
subsidiaries ("the Company" or "ESG"). This discussion and analysis should be
read in conjunction with the "Selected Consolidated Financial Data" and the
Company's Consolidated Financial Statements and related notes thereto included
elsewhere in this annual report.
This annual report contains forward-looking statements regarding future
profit levels, premium growth, cash flows and other matters, which involve risks
and uncertainties that may affect the actual results of operations of the
Company. The following important factors, among others, could cause actual
results to differ materially from those set forth in the forward-looking
statements: claims frequency, claims severity, economic activity, competitive
pricing, and the regulatory environment in which the Company operates.
GENERAL
The Company is a specialty reinsurance enterprise providing accident, health,
life and related special risk reinsurance to insurers and selected reinsurers on
a worldwide basis and, underwriting management services to co-reinsurers. In
addition, the Company established a direct insurance company in the second
quarter of 1998 to write pan-European products.
In December 1997, the Company raised gross proceeds of $257 million in a
private placement and an initial public offering (the "Offerings"). As a result
of obtaining this capital, the Company is able to assume reinsurance risks for
its own account. Prior to the Offerings, the Company operated solely as a
reinsurance management services company.
The December 31, 1998, financial statement results included herein reflect
the Company's financial performance as a reinsurance company. The December 31,
1997 financial statement results reflect the Company's financial performance as
a reinsurance company and as a reinsurance management services company. The 1996
financial statement results reflect the Company's operations as a reinsurance
management services company only.
RESULTS OF OPERATIONS
The results of operations of the Company for the years ended December 31, 1998,
1997 and 1996 were as follows:
<TABLE>
<CAPTION>
1998 1997 1996
=================================================================================
<S> <C> <C> <C>
U.S. dollars in thousands except per share data
Net underwriting income before allocated
administrative costs $10,763 $ 1,269 $ --
Management fee revenue 1,894 3,830 3,869
Net investment income 12,930 598 186
Net realized investment gains 2,162 -- --
Administrative expenses and taxes 13,227 7,167 4,218
Class B Warrants expense -- 3,626 --
Net income (loss) 14,522 (5,096) (163)
Net income (loss) per share 1.04 (4.11) (1.38)
========== ========== ==========
</TABLE>
25
<PAGE> 18
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
The Company reported net income of $14.5 million for 1998, compared to a net
loss of $5.1 million for 1997. The year ended December 31, 1998 represents the
first full year of the Company's operation as a reinsurance company. The net
loss incurred in 1997 includes a one-time, non-cash charge for compensation
expense of $3.6 million related to Class B Warrants issued in connection with
the Offerings, and approximately $1.5 million of other Offerings related costs.
NET UNDERWRITING INCOME
For the year ended December 31, 1998, the Company managed, on behalf of itself
and its co-reinsurers, total premiums of $224.2 million, of which it placed
$24.3 million with co-reinsurers and retroceded $4.3 million, resulting in
$195.6 million net premiums written for the period. In December 1997, the
Company assumed a portion of the pool business it previously managed on behalf
of reinsurance clients, retroactive to January 1, 1997. For the year ended
December 31, 1997, the Company managed approximately $100 million of gross
premiums written, of which it assumed approximately $26 million. Gross and net
premiums written and net premiums earned for the 12 months ended December 31,
1998 and 1997 were as follows:
<TABLE>
<CAPTION>
Years Ended December 31, 1998 1997
===============================================================================
<S> <C> <C>
U.S. dollars in millions
Total premiums managed $224.2 $100.0
Amount placed with co-reinsurers or pool participants 24.3 73.9
Gross premiums written 199.9 26.1
Net premiums written 195.6 25.4
Net premiums earned 98.8 13.4
====== ======
</TABLE>
Total premiums managed for the 12 months ended December 31, 1998 consisted
of the following:
o New Business - approximately $186.2 million, or 83.0%, of total premiums
managed was generated from new business. The Company's new representative
office in Toronto underwrote $85.9 million of gross premiums. Two
significant contracts for European medical, personal accident and life
business were underwritten in the first quarter, including one for quota
share treaty reinsurance incepting January 1, 1997. These contracts
contributed $22.5 million to total premiums managed for the 12 months ended
December 31, 1998. Additionally, one significant North American medical
contract was underwritten in the third quarter, contributing $21.6 million
to total premiums managed.
o Renewal Business - approximately $38.0 million, or 17.0%, of total premiums
managed was generated from renewal business. Underwriting results for the
12 months ended December 31, 1998 and 1997, by line of business and in
total, were as follows:
<TABLE>
<CAPTION>
Personal
Year Ended December 31, 1998 Medical Accident Special Risk Credit Life Total
====================================================================================================================================
<S> <C> <C> <C> <C> <C> <C>
U.S. dollars in thousands
Gross premiums written $ 119,157 $ 52,254 $ 5,120 $ 12,346 $ 10,995 $ 199,872
Net premiums written 117,353 50,814 4,943 11,910 10,558 195,578
Net premiums earned 40,875 46,038 2,571 4,856 4,501 98,841
Losses and loss expenses 24,646 29,003 859 3,448 3,408 61,364
Acquisition costs 14,241 10,207 906 837 523 26,714
Operating costs 3,584 4,036 228 420 534 8,802
--------- --------- --------- --------- --------- ---------
Net underwriting income (loss) $ (1,596) $ 2,792 $ 578 $ 151 $ 36 $ 1,961
========= ========= ========= ========= ========= =========
</TABLE>
<PAGE> 19
<TABLE>
<CAPTION>
Personal
Year Ended December 31, 1997 Medical Accident Special Risk Credit Life Total
====================================================================================================================================
<S> <C> <C> <C> <C> <C> <C>
U.S. dollars in thousands
Gross premiums written $ 9,989 $ 9,357 $ 396 $ 6,401 $-- $ 26,143
Net premiums written 9,937 8,723 376 6,356 -- 25,392
Net premiums earned 5,964 3,778 243 3,426 -- 13,411
Losses and loss expenses 3,624 1,907 139 1,779 -- 7,449
Acquisition costs 2,099 1,303 85 1,206 -- 4,693
--------- --------- --------- --------- --------- ---------
Net underwriting income $ 241 $ 568 $ 19 $ 441 $-- $ 1,269
========= ========= ========= ========= ========= =========
</TABLE>
The operating ratios for the 12 months ended December 31, 1998 and 1997, by
line of business and in total, were as follows:
<TABLE>
<CAPTION>
Personal
Year Ended December 31, 1998 Medical Accident Special Risk Credit Life Total
====================================================================================================================================
<S> <C> <C> <C> <C> <C> <C>
Loss ratio 60.3% 63.0% 33.4% 71.0% 75.7% 62.1%
Acquisition expense ratio 34.8% 22.2% 35.2% 17.2% 11.6% 27.0%
--------- --------- --------- --------- --------- ---------
Loss and acquisition expense
ratio 95.1% 85.2% 68.6% 88.2% 87.3% 89.1%
--------- --------- --------- --------- --------- ---------
Administrative expense ratio 8.9%
---------
Combined ratio 98.0%
=========
</TABLE>
<TABLE>
<CAPTION>
Personal
Year Ended December 31, 1997 Medical Accident Special Risk Credit Life Total
====================================================================================================================================
<S> <C> <C> <C> <C> <C> <C>
Loss ratio 60.8% 50.5% 57.2% 51.9% --% 55.5%
Acquisition expense ratio 35.2% 34.5% 35.0% 35.2% --% 35.0%
--------- --------- --------- --------- --------- ---------
Loss and acquisition expense
ratio 96.0% 85.0% 92.2% 87.1% --% 90.5%
========= ========= ========= ========= ========= =========
</TABLE>
The 12 months ended December 31, 1998 constituted the first full 12-month
period that the Company operated as a reinsurer writing for its own account.
Accordingly, a combined ratio is presented inclusive of an administrative
expense component to provide a meaningful indication of the underwriting results
of the business. The administrative expense ratio of 8.9% for the 12 months
ended December 31, 1998, was calculated by expressing total administrative
expenses, net of management fee revenue and corporate office expenses, as a
percentage of net premiums earned. In addition, during the year, the Company
deferred $1.5 million of expenses which were identified by management as
directly related to and, varying with, the volume of business generated. The
deferral of such costs reflects a more appropriate matching of revenues with
related expenses and improved the year-to-date combined ratio by 1.5%.
Typically, the underwriting results of a reinsurance company are evaluated
by its loss and loss expense ratio, acquisition cost ratio, administrative
expense ratio and combined ratio. Management believes that it is not meaningful
to evaluate the Company's 1997 performance with reference to the administrative
expense ratio and combined ratio because of the Class B Warrant expense and
other costs that were incurred by the Company as a result of the Offerings.
GEOGRAPHIC SPREAD
Geographic diversification of the Company's business continues to be
demonstrated by the distribution of gross written premiums for the years ended
December 31, 1998 and 1997, as follows:
<TABLE>
<CAPTION>
Years Ended December 31, 1998 1997
===============================================================================
<S> <C> <C>
Western Europe 30.9% 62.7%
North America 46.2% 1.5%
Latin America 14.9% 19.2%
Eastern Europe 0.1% 5.3%
Other 7.9% 11.3%
----- -----
Total 100.0% 100.0%
===== =====
</TABLE>
<PAGE> 20
PRODUCT MIX
The distribution of gross premiums written by line of business for the years
ended December 31, 1998 and 1997 was as follows:
<TABLE>
<CAPTION>
Years Ended December 31, 1998 1997
===============================================================================
<S> <C> <C>
Medical 59.6% 38.2%
Personal Accident 26.1% 35.8%
Special Risk 2.6% 1.5%
Credit 6.2% 24.5%
Life 5.5% --%
----- -----
Total 100.0% 100.0%
===== =====
</TABLE>
MANAGEMENT FEE REVENUE
The majority of management fee revenue in 1998 consists of fees earned on those
premiums managed for the Company's co-reinsurers. Management fee revenue in 1998
includes an upward revision in management fees on pool underwriting years prior
to 1998 in the amount of $144 thousand.
NET INVESTMENT INCOME
Net investment income increased by $12.3 million from $598 thousand in 1997 to
$12.9 million in 1998. In December 1997, the Company raised net proceeds from
the Offerings of $232 million. These proceeds were invested for the full year in
1998.
The following table reflects the investment results for the 12 months ended
December 31, 1998:
<TABLE>
<CAPTION>
Net Annualized Net Realized
Average Investment Effective Investment
U.S. dollars in thousands Investments Income(1) Yield Gains
=================================================================================================================
<S> <C> <C> <C> <C>
Fixed maturity investments $218,383 $12,160 5.57% $2,162
Short-term investments/strategic investments 7,721 440 5.70% --
Cash and cash equivalents 13,516 330 2.44% --
-------- ------- ---- ------
Total $239,620 $12,930 5.40% $2,162
======== ======= ==== ======
</TABLE>
(1) Net investment income is net of investment-related expenses.
The Company's investment portfolio was positively affected by a general increase
in prices in the U.S. bond markets, which allowed net investment gains to be
realized on sales of fixed income securities during the year.
ADMINISTRATIVE EXPENSES
Total administrative expenses, which includes personnel costs, professional
service fees, interest expense, other expenses and income taxes, increased by
$6.0 million, or 85%, from $7.2 million in 1997 to $13.2 million in 1998.
For the year ended December 31, 1998, the Company incurred significant
expenses on professional services, on initiatives for improving accounting and
control systems, hiring key executives, and identifying strategic investments,
and on travel expenses related to all of the above activities. Total
administrative expenses, less tax, for the 12 months ended December 31, 1998,
were $12.0 million, or 6.1% and 12.1%, respectively, of net premiums written and
net premiums earned, compared to $7.7 million in 1997. The prior year expenses
include $1.5 million of travel expense and professional service fees associated
with the Company's capital raising activity. Tax expense increased by $1.8
million to $1.3 million in 1998. In 1997, the Company had a tax benefit of $569
thousand.
Personnel costs increased by $2.1 million from $2.3 million in 1997 to $4.4
million in 1998. This increase was a result of the significant investment in
personnel made both prior to and since the Offerings and includes additions of
executives and staff at the holding company and various representative offices.
Professional service fees increased by $2.0 million from $1.6 million in 1997 to
$3.6 million in 1998. These professional service fees incurred in 1998 relate to
the Company's new public reporting requirements, staff recruiting efforts and
computer systems improvements. Professional costs in 1997 include $1.2 million
associated with the Company's capital-raising activity. Travel expenses
decreased by $0.3 million to $1.0 million, compared to the corresponding prior
year period. These travel expenses relate primarily to the Company's continuing
identification and investigation of new business and underwriting opportunities.
Foreign exchange gains of $141 thousand were recognized for the 12 months
ended December 31, 1998. These gains were primarily unrealized and were incurred
on the revaluation of assets and liabilities denominated in foreign currencies
for reporting purposes. As the Company maintains a partial natural hedge,
whereby foreign currency assets are held in the same currencies in which it must
pay liabilities, the impact on cash flows from foreign exchange movements is
reduced.
<PAGE> 21
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
The Company incurred a net loss of $5.1 million for 1997 as compared to a net
loss of $163 thousand for 1996. The principal reason for this increase in the
net loss is a one-time, non-cash charge for compensation expense of $3.6 million
related to Class B Warrants issued in connection with the Offerings. Also
included in the net loss for 1997 are costs associated with the Offerings of
approximately $1.5 million.
NET UNDERWRITING INCOME
No comparison with prior year net underwriting income is possible as 1997 was
the first period in which the Company underwrote risks on its own behalf.
Typically the underwriting results of a reinsurance company are evaluated by its
loss and loss expense ratio, acquisition cost ratio, administrative expense
ratio and combined ratio. Management believes that it is not meaningful to
evaluate the Company's 1997 performance with reference to the administrative
expense ratio and combined ratio because of the Class B Warrant expense and
other costs that were incurred by the Company as a result of the Offerings.
MANAGEMENT FEE REVENUE
Management fee revenue decreased by $39 thousand, or 1%, from $3.9 million in
1996 to $3.8 million in 1997. This net decrease resulted from an increase in
management fee revenue of $666 thousand due to increased participation in the
reinsurance pools managed by the Company, offset by a 15% decline in the value
of the Deutsche mark against the U.S. dollar. Included in 1997 management fee
revenue is profit commission of $381 thousand relating to the 1996 underwriting
year. This compares with profit commission recognized during 1996 of $398
thousand.
NET INVESTMENT INCOME
Net investment income increased by $412 thousand, or 222%, from $186 thousand in
1996, due to the Company's significantly larger investment portfolio as a result
of the proceeds raised from the Offerings.
ADMINISTRATIVE EXPENSES
Total administrative expenses, which includes personnel costs, professional
service fees, interest expense, other expenses, and income taxes, increased by
$3.0 million, or 70%, from $4.2 million in 1996 to $7.2 million in 1997.
Personnel costs increased by $900 thousand, from $1.4 million in 1996 to
$2.3 million in 1997, of which $690 thousand was principally due to the
employment of two executives who were previously consultants to the Company. The
remainder of the increase results from the staffing of the new representative
office in Toronto. Professional service fees increased by $356 thousand from
$1.2 million in 1996 to $1.6 million in 1997, primarily due to costs of $1.2
million associated with the Company's capital-raising activity. This increase
was partially offset by a reduction in consulting expenses for the two
consultants who became executives.
Other expenses increased by $2.4 million, from $1.4 million in 1996 to $3.8
million in 1997. This increase includes travel expenses associated with the
Company's capital-raising activities, an increase in unrealized foreign exchange
losses as a result of the strengthening of the U.S. dollar, and other
miscellaneous expenses, including insurance, recruitment fees, taxes and
utilities. The increase in administrative expenses was partially offset by a
decline of approximately 15% in the value of the Deutsche mark against the U.S.
dollar.
CLASS B WARRANTS EXPENSE
In connection with the Offerings, the Company issued Class A Warrants to
purchase up to 1,381,200 Common Shares, and Class B Warrants to purchase up to
1,381,200 Common Shares if certain performance criteria are satisfied. The Class
A Warrants have been treated as an offering cost and as such have been
incorporated within equity.
The Class B Warrants have been determined to be in the form of compensation
for services rendered to the Company. As such, SFAS 123 "Accounting for
Stock-Based Compensation" and Emerging Issues Task Force Consensus 96-18
"Accounting for Equity Instruments that are Issued to Other than Employees for
Acquiring or in Conjunction with Selling Goods or Services" require that the
cost of these services be reflected as an expense for the year.
As a result, the Company recognized a one-time accounting charge of $3.6
million relating to the Class B Warrants. The expense was calculated based on
the fair value of the warrants as of the date of completion of the Offerings. As
the expense was reflected as a charge to the statement of operations and as an
increase to additional paid-in capital, there was no impact on the Company's
total shareholders' equity or cash position.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 1998, total investments and cash were $235.2 million,
compared to $237.0 million at December 31, 1997. All fixed maturity securities
in the Company's investment portfolio are classified as available for sale and
are carried at fair value. The following table summarizes the fixed maturity
investment portfolio as of December 31, 1998:
<TABLE>
<CAPTION>
Average
Fair Duration Market Credit
U.S. dollars in thousands Value (Years) Yield Rating
==================================================================================================================
<S> <C> <C> <C> <C>
Corporate securities $138,727 3.1 5.7% AA
U.S. treasury securities and obligations of
U.S. government corporations and agencies 31,698 1.5 4.4% AAA
Asset-backed securities/Mortgage-backed securities 9,232 0.8 5.8% AAA
Obligations of states and political subdivisions 24,647 2.3 5.9% AA
Foreign currency debt securities 8,083 3.4 3.5% AA
-------- --- --- ---
Total $212,387 2.6 5.2% AA
======== === === ===
</TABLE>
By comparison, at December 31, 1997, the entire portfolio was invested in U.S.
treasury securities and obligations of government corporations and agencies.
<PAGE> 22
The Company's investment policy objective is to maximize long-term
investment returns while maintaining a liquid, high-quality portfolio. To this
end, the investment policy requires that the portfolio have an average credit
quality rating of AA, with no more than 3% of the portfolio invested in the
securities of a single issuer (other than issues of sovereign governments with a
rating of AA or better), and a target duration of 2.75 years. The Company's
investment portfolio as of December 31, 1998 and 1997 complies with the adopted
investment policy and guidelines.
In 1999, the Company will continue to follow its investment policy and
guidelines while seeking to improve long-term value by investing in selected
strategic investments. A strategic investment is defined as an investment in a
reinsurance-related enterprise, ceding company or distribution channel that is
expected to generate or secure additional profitable business for the Company.
In the aggregate, the Company will allocate up to $25 million to strategic
investments. To date, ESGhas invested $2.0 million and acquired an 83% ownership
interest in IMEDI L International, a provider of personal insurance products,
including medical, life and pension products, based in Tbilisi, Georgia.
Additionally, equity investments and loans totaling $5.9 million were extended
primarily to four other companies with whom ESG has operating relationships.
In December 1997, the Company was capitalized with gross proceeds of $257
million from the Offerings. The Company also incurred expenses of $25 million
related to the Offering and repaid its outstanding debt, principally loans from
shareholders and bank demand borrowings, of $3.5 million. Total assets increased
by $281.1 million from $2.5 million in 1996 to $283.6 million in 1997 and total
shareholders' equity increased by $234.9 million to $234.4 million at December
31, 1997. The proceeds of the Offering were used to capitalize ES Bermuda, ES
Ireland and ES Germany with $55 million, $50 million and $12 million,
respectively.
In 1998, the Company increased the capital of ES Bermuda by $35 million,
and ES Ireland by $50 million. Accent Europe Insurance Company, the direct
writer formed in 1998, is capitalized at $15 million.
Shareholders' equity as of December 31, 1998 was $244.8 million, compared
to $ 234.4 million at December 31, 1997. The major factors influencing the
increased level of shareholders' equity in the 12-month period included $14.5
million of net income, inclusive of net unrealized investment gains of
approximately $2.6 million, offset partially by the declaration of four
dividends, each of $0.075 per common share, aggregating to $4.2 million. Book
value per common share increased to $17.58 as of December 31, 1998 from $16.83
as of December 31, 1997.
The Company expects that its financial and operational needs for the
foreseeable future will be met by funds generated from operations, but may
consider acquiring additional funding as attractive market opportunities emerge.
As of December 31, 1998, the Company had the following material commitments
for operating leases and employment contracts:
<TABLE>
<CAPTION>
Total Commitments In U.S. Dollars (in thousands) Lease Employee
Years Ending December 31, Commitments Commitments Total
=================================================================================================================
<S> <C> <C> <C>
1999 $ 476 $2,514 $2,990
2000 487 2,316 2,803
2001 349 1,130 1,479
2002 72 763 835
2003 -- 253 253
------ ------ ------
Total $1,384 $6,976 $8,360
====== ====== ======
</TABLE>
In addition to the above commitments, the Company will periodically,
pursuant to reinsurance contract provisions, be required to provide letters of
credit to secure reinsurance balances, and to place funds on deposit with ceding
companies.
EXPOSURE MANAGEMENT
The Company manages its underwriting risk exposures through geographic
distribution and an excess of loss reinsurance program. This program generally
provides limits up to a maximum of $30 million per occurrence, with a minimum
attachment point generally of $100 thousand.
CURRENT DEVELOPMENTS
On February 25, 1999, the Board of Directors approved a quarterly dividend
increase of $0.005 per common share, increasing the quarterly dividend from
$0.075 to $0.08 per share. A quarterly cash dividend of $0.08 per share was
declared on February 25, 1999 by the Company's Board of Directors, payable on
March 22, 1999 to common shareholders of record on March 15, 1999.
In June 1998, the Company increased its investment in SportSecure GmbH
("SportSecure"), a reinsurance intermediary specializing in sports and
entertainment risks. ESG holds a majority ownership interest in SportSecure.
In June 1998, the Company incorporated Accent Europe Insurance Company
Ltd., a direct insurance company, in Ireland. With current capitalization at $15
million, Accent offers health and accident products on a pan-European basis
directly to its insured parties.
<PAGE> 23
Early in the fourth quarter, the Company began the process of establishing
a global support center (the "Shared Services Center") in Dublin, Ireland.
Corporate functions expected to operate from the Shared Services Center include
operating and administrative functions such as systems and technology, finance
and accounting, human resources, insurance claims, and policy administration.
The Company has initiated the creation of a healthcare service association,
COMED, in the German market. COMED has a target market of an estimated 70
million members covered in the German public healthcare system. Member services
include physician referrals, a medical information hotline, second opinion
services and access to disease management advisors. ESG has supported the
formation and development of COMEDby extending a short-term credit facility up
to the amount of $12 million to fund start-up operations. As of December 31,
1998 no funds had been advanced to COMED under this facility.
MARKET RISK
The Company is subject to market risk arising from the potential change in value
of its various financial instruments. These changes may be due to fluctuations
in interest rates or foreign currency rates, or both in the case of foreign
currency investments. The Company monitors its exposure to interest rate and
currency rate risk on a continuous basis and currently does not believe that the
use of derivatives to manage such risk is necessary. The Company intends to
reevaluate the need for a formal hedging strategy on a periodic basis, and may
determine that such a strategy, including the use of derivative instruments, is
appropriate in the future.
INTEREST RATE RISK
The largest source of market risk for the Company is interest rate risk on its
portfolio of fixed maturity investments, especially fixed rate instruments. In
addition, the credit worthiness of the issuer, relative values of alternative
investments, liquidity and general market conditions may affect fair values of
interest rate sensitive instruments.
The Company's general strategy with respect to fixed maturity securities is
to invest in high quality securities while maintaining diversification to avoid
significant concentrations in individual issuers' industry segments or
countries.
Generally, it is expected that an increase in market interest rates will
cause a decline in the value of the Company's investment portfolio, whereas a
decrease in rates may cause an increase in value. The following table shows the
approximate effect on the value of the Company's investment portfolio, based on
hypothetical changes in market interest rates:
<TABLE>
<CAPTION>
-150 -100 -50 Market +50 +100 +150
December 31, 1998 Basis Basis Basis Value Basis Basis Basis
U.S. dollars in thousands Points Points Points 12/31/98 Points Points Points
====================================================================================================================================
<S> <C> <C> <C> <C> <C> <C> <C>
Fixed maturities including accrued interest $227,404 $223,457 $219,664 $216,016 $212,511 $209,130 $205,867
======== ======== ======== ======== ======== ======== ========
</TABLE>
The values indicated above are estimates and are necessarily based on various
assumptions that are subjective in nature. Accordingly, the actual impact of
changes in market rates on the Company's investment portfolio may be
significantly greater or less than those indicated above.
FOREIGN CURRENCY RISK
The Company's functional currency is the U.S. dollar. However, the Company
writes reinsurance business in numerous geographic regions and currencies,
giving rise to the risk that the ultimate settlement of receivables and payables
on reinsurance transactions will differ from the amounts currently recorded as
assets and liabilities in the financial statements. The Company intends to hold
investments in currencies in which it will collect premiums and pay claims, thus
creating a partial natural hedge against exchange rate fluctuations.
INFLATION
Inflation has not had a material impact on the Company's operations for any of
the three years presented. However, it is possible that future inflationary
conditions may impact subsequent accounting periods.
THE EURO
On January 1, 1999, a single currency, the "Euro," was adopted as the national
currency of the 11 participating countries in the European Monetary Union,
including Germany and Ireland, two of the countries in which the Company
operates and in which the Company maintains a significant presence. ESG's German
and Irish subsidiaries will not be required to use the euro for accounting
purposes prior to January 1, 2002. Due to uncertainties related to the euro
conversion, the impact of the conversion is not known. To date, the impact of
the conversion has had no material impact on the Company's operations,
accounting systems or financial reporting.
<PAGE> 24
YEAR 2000 ISSUE
The Year 2000 Issue relates to the ability of computer systems to properly
interpret date information for the year 2000 and beyond. In January 1998, the
Company initiated an enterprise-wide project to address Year 2000 issues with
respect to the Company's computer software and information technology systems.
The initiative has as its focus two distinct areas that include Year 2000
compliance of the Company's software, systems and technology platforms and the
evaluation of the Year 2000 preparedness of significant third parties with whom
the Company conducts business, including vendors and customers.
The Company has substantially completed its assessment of Company software
and systems and has adopted a plan to implement compliant components and to
develop a disaster recovery plan, targeted to be substantially complete by the
end of the second quarter of 1999. The Company estimates that through December
1998, the remediation and validation efforts are approximately 60% complete,
with immaterial incremental costs incurred thus far as a result of usage of
internal staff. Remaining testing and conversion efforts also are expected to be
conducted primarily by internal staff; however, limited third-party assistance
during the first two quarters of 1999 may be utilized. No significant
third-party costs are anticipated. Future costs of remediation are not expected
to have a material impact on the Company's financial position, results of
operations or cash flows, although no assurance can be given in this regard.
The Company's systems do not interface electronically with those of its
customers or clients. As such, the Company's exposure to the Year 2000 Issue
with respect to customers and clients is limited to the possibility that
information supplied by these companies could not be of sufficient quality or
timeliness and therefore could indirectly affect the quality or timeliness of
the Company's own data. The Company is currently communicating with its
significant clients and service providers to assess their vulnerability and
readiness to comply with Year 2000 issues and will address compliance risks with
each new significant vendor.
ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"). SFAS 133, which is effective in the first
quarter of 2000, establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
financial instruments and contracts, and for hedging activities. The Company has
not completed its analysis of the expected future impact of SFAS 133.
<PAGE> 25
<TABLE>
ESGRE LIMITED
CONSOLIDATED BALANCESHEETS
<CAPTION>
As of December 31, 1998 1997
====================================================================================================================================
U.S. dollars in thousands except share and per share data
ASSETS
<S> <C> <C>
Fixed maturities - available for sale, at fair value (cost: $211,589 and $218,694) $ 212,387 $ 218,867
Cash and cash equivalents 16,942 6,196
Strategic investments 5,917 --
Short-term investments -- 11,913
--------- ---------
Total investments and cash 235,246 236,976
Accrued investment income 3,629 437
Management fees receivable 3,164 3,259
Premiums receivable 162,015 25,785
Reinsurance balances receivable 6,259 --
Reinsurance recoverable on incurred losses 2,761 397
Funds held by ceding companies 3,592 --
Prepaid reinsurance premiums 2,276 300
Deferred acquisition costs 37,625 4,147
Deferred tax asset 843 788
Other assets 2,222 979
Cash and cash equivalents held in a fiduciary capacity 6,741 10,485
--------- ---------
TOTAL ASSETS $ 466,373 $ 283,553
========= =========
LIABILITIES
Unpaid losses and loss expenses $ 44,379 $ 7,846
Unearned premiums 111,884 12,168
Acquisition costs payable 45,487 10,335
Reinsurance balances payable 7,114 --
Accrued expenses, accounts payable, and other liabilities ($204 and $2,520
due to related parties) 5,927 8,344
Fiduciary liabilities 6,741 10,485
--------- ---------
Total liabilities 221,532 49,178
--------- ---------
SHAREHOLDERS' EQUITY
Preference shares, 50,000,000 shares authorized; no shares issued and
outstanding for 1998 and 1997 -- --
Class B common shares, 100,000,000 shares authorized; no shares issued
and outstanding for 1998 and 1997 -- --
Common shares, par value $1 per share; 100,000,000 shares authorized;
13,923,799 shares issued and outstanding for 1998 and 1997 13,924 13,924
Additional paid-in capital 226,216 225,954
Accumulated other comprehensive income:
Foreign currency translation adjustments (574) 32
Unrealized gains on securities (net of tax of $164 and $3) 634 170
--------- ---------
Accumulated other comprehensive income 60 202
--------- ---------
Retained earnings (deficit) 4,641 (5,705)
--------- ---------
Total shareholders' equity 244,841 234,375
--------- ---------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 466,373 $ 283,553
========= =========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
<PAGE> 26
ESGRE LIMITED
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Years Ended December 31, 1998 1997 1996
====================================================================================================================================
<S> <C> <C> <C>
U.S. dollars in thousands except share and per share data
REVENUES
Net premiums written $ 195,578 $ 25,392 $ --
Change in unearned premiums (96,737) (11,981) --
------------ ------------ ------------
Net premiums earned 98,841 13,411 --
Management fee revenue 1,894 3,830 3,869
Net investment income 12,930 598 186
Net realized investment gains 2,162 -- --
------------ ------------ ------------
115,827 17,839 4,055
------------ ------------ ------------
EXPENSES
Losses and loss expenses 61,364 7,449 --
Acquisition costs 26,714 4,693 --
Class B Warrants expense (for related party) -- 3,626 --
Personnel costs 4,352 2,282 1,382
Professional service fees (includes $378, $-- and $861 for related parties) 3,599 1,594 1,238
Other expenses 4,014 3,860 1,442
------------ ------------ ------------
100,043 23,504 4,062
============ ============ ============
NET INCOME (LOSS) BEFORE TAXES 15,784 (5,665) (7)
Income tax expense (benefit) 1,262 (569) 156
------------ ------------ ------------
NET INCOME (LOSS) $ 14,522 $ (5,096) $ (163)
============ ============ ============
PER SHARE DATA
Basic net income (loss) per share $ 1.04 $ (4.11) $ (1.38)
------------ ------------ ------------
Diluted net income (loss) per share $ 1.03 $ (4.11) $ (1.38)
------------ ------------ ------------
Weighted average shares outstanding
Basic 13,923,799 1,238,757 117,863
Diluted 14,076,443 1,238,757 117,863
============ ============ ============
Dividends declared per share $ .30 $ -- $ --
============ ============ ============
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
<PAGE> 27
ESGRE LIMITED
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
Years Ended December 31, 1998 1997 1996
====================================================================================================================================
<S> <C> <C> <C>
U.S. dollars in thousands
COMMON SHARES (PAR VALUE)
Balance at January 1 $ 13,924 $ 62 $ --
Reorganization of holding company -- -- 62
Issuance of shares in connection with public and private offerings -- 13,936 --
Shares retired during year -- (74) --
--------- --------- ---------
Balance at December 31 13,924 13,924 62
========= ========= =========
ADDITIONAL PAID-IN CAPITAL
Balance at January 1 225,954 62 --
Reorganization of holding company -- -- 62
Issuance of shares in connection with public and private offerings -- 216,113 --
Issuance of Class A Warrants to purchase common shares -- 6,215 --
Issuance of Class B Warrants to purchase common shares -- 3,626 --
Directors' fees taken as stock options 347 -- --
Additional offering costs (85) -- --
Shares retired during year -- (62) --
--------- --------- ---------
Balance at December 31 226,216 225,954 62
========= ========= =========
REGISTERED CAPITAL AND TREASURY CAPITAL
Balance at January 1 -- -- 297
Reorganization of holding company -- -- (297)
--------- --------- ---------
Balance at December 31 -- -- --
========= ========= =========
ACCUMULATED OTHER COMPREHENSIVE INCOME
Balance at January 1 202 (4) (3)
Foreign currency translation adjustments, net of tax (606) 36 (1)
Unrealized gains on securities, net of tax 464 170 --
--------- --------- ---------
Balance at December 31 60 202 (4)
========= ========= =========
RETAINED EARNINGS (DEFICIT)
Balance at January 1 (5,705) (609) (446)
Net income (loss) 14,522 (5,096) (163)
Dividends (4,176) -- --
--------- --------- ---------
Balance at December 31 4,641 (5,705) (609)
--------- --------- ---------
TOTAL SHAREHOLDERS' EQUITY (DEFICIT) $ 244,841 $ 234,375 $ (489)
========= ========= =========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
<PAGE> 28
ESGRE LIMITED
CONSOLIDATED STATEMENTS OF CASHFLOWS
<TABLE>
<CAPTION>
Years Ended December 31, 1998 1997 1996
===================================================================================================================================
<S> <C> <C> <C>
U.S. dollars in thousands
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ 14,522 $ (5,096) $ (163)
Adjustments to reconcile net income (loss) to net cash provided by
(used in) operating activities:
Depreciation and amortization 252 117 132
Realized investment gains (2,162) -- --
Amortization of premiums and discounts 200 -- --
Non-cash compensation expenses 347 3,665 --
Changes in assets and liabilities:
Accrued investment income (3,192) (437) --
Management fees receivable 95 (1,769) 139
Premiums receivable (136,230) (25,785) --
Reinsurance balances receivable (6,259) -- --
Reinsurance recoverable on incurred losses (2,364) (397) --
Funds held by ceding companies (3,592) -- --
Prepaid reinsurance premiums (1,976) (300) --
Deferred acquisition costs (33,478) (4,147) --
Deferred tax asset (55) (573) (1)
Unpaid losses and loss expenses 36,533 7,846 --
Unearned premiums 99,716 12,168 --
Acquisition costs payable 35,152 10,335 --
Reinsurance balances payable 7,114 -- --
Accrued expenses and accounts payable (2,579) 1,075 --
Other assets and liabilities (1,065) 775 32
--------- --------- ---------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES 979 (2,523) 139
========= ========= =========
CASH FLOWS FROM INVESTING ACTIVITIES
Cost of fixed maturities acquired - available for sale (436,239) (218,694) --
Proceeds from sale of fixed maturities - available for sale 445,305 -- --
Change in short-term investments 11,913 (11,913) --
Purchases of fixed assets (967) (203) (109)
Purchases of intangible assets (57) (230) (43)
Funding of strategic investments (5,917) (16) (4)
--------- --------- ---------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES 14,038 (231,056) (156)
========= ========= =========
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of shares -- 241,296 --
Changes to capital prior to initial public offering -- -- (13)
Net change in short-term debt -- (1,622) 296
Repayments of long-term borrowings -- -- (272)
Additional offering costs (85) -- --
Dividends paid (4,177) -- --
--------- --------- ---------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES (4,262) 239,674 11
--------- --------- ---------
EFFECT OF EXCHANGE RATE CHANGES ON CASH (9) 86 (12)
========= ========= =========
Net increase (decrease) in cash 10,746 6,181 (18)
Cash and cash equivalents at January 1 6,196 15 33
--------- --------- ---------
Cash and cash equivalents at December 31 $ 16,942 $ 6,196 $ 15
========= ========= =========
SUPPLEMENTAL CASH FLOW INFORMATION
Cash transactions
Interest paid $ 8 $ 108 $ 124
Income taxes paid 40 109 156
Non-cash financing transaction
Issuance of common stock in connection with Formation (Note 1) -- -- --
========= ========= =========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
<PAGE> 29
ESGRe Limited Notes to the Consolidated Financial Statements
<TABLE>
ESGRE LIMITED
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
<CAPTION>
Years Ended December 31, 1998 1997 1996
====================================================================================================================================
<S> <C> <C> <C>
U.S. dollars in thousands
Net income (loss) $ 14,522 $ (5,096) $ (163)
-------- -------- --------
Other comprehensive income, net of tax:
Foreign currency translation adjustments (606) 36 (1)
Unrealized gains on securities:
Unrealized holding gains arising during period, net of tax of $172 and $32,615 170 --
Less reclassification adjustment for gains
included in net income, net of tax of $11 (2,151) -- --
-------- -------- --------
Other comprehensive income (142) 206 (1)
-------- -------- --------
Comprehensive income $ 14,380 $ (4,890) $ (164)
======== ======== ========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
<PAGE> 30
ESGRE LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 1998, 1997, 1996
1. ORGANIZATION AND BUSINESS
ESG Re Limited ("the Company") was incorporated under the laws of Bermuda on
August 21, 1997. Its principal activities conducted through its subsidiaries,
are to provide accident, health, credit, life and special risk reinsurance and
to provide underwriting management services for these lines.
Prior to the incorporation, the Company's operations were conducted through
its subsidiary, European Specialty Group Holding AG ("ESG Germany"). On December
2, 1997, the shareholders of ESG Germany entered into agreements to receive
900,000 common shares, par value $1 per share, of the Company in exchange for
all of their interests in ESG Germany (the "Formation"). ESG Germany thereby
became a subsidiary of the Company.
On December 3, 1997, 2,673,799 common shares, Class A Warrants to purchase
up to 1,381,200 common shares and Class B Warrants to purchase up to 1,381,200
common shares, subject to certain performance criteria, were sold (the "Direct
Sales") for proceeds of $50 million.
In December 1997, in an Initial Public Offering (the "IPO"), the Company
issued 10,350,000 common shares for proceeds of $207 million. Costs including
discounts and commissions associated with the Formation, Direct Sales and IPO
were approximately $25.8 million, of which $21.3 million were reflected as a
reduction of additional paid-in capital. The Formation, Direct Sales and IPO
were accounted for as a recapitalization.
Since 1994, ESG Germany has provided underwriting management services by
operating as a personal and special risk reinsurance underwriter on behalf of
certain reinsurers. ESG Germany earned a management fee from reinsurance
companies for administering various underwriting pools without directly
participating in the underwriting results as well as providing underwriting
services to reinsurance companies outside of the pool structure.
Subsequent to the IPO, the Company assumed for its own account, through
retrocession, risks that ESG Germany previously underwrote on behalf of its
reinsurance clients. The Company exercised a contractual right provided in the
pool agreements to retrocede from its reinsurance clients a 30% share of the
existing pool business, retroactive to January 1, 1997, of the 1997 business it
managed for its reinsurance clients. The Company also assumed additional quota
share reinsurance from various pool clients. The Company continues to manage the
runoff of the reinsurance pools.
The consolidated financial statements include the accounts of the Company
and its subsidiaries. All material intercompany balances and transactions have
been eliminated in consolidation.
The financial statements for the year ended December 31, 1997 represent the
financial performance of the Company both as a reinsurer for its own account and
as a reinsurance management company. The comparative information for the year
ended December 31, 1996 represents the financial performance of the Company as
an underwriting management company. Certain items in the prior years' financial
statements have been reclassified to conform to the current years' presentation.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Company's consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States of America
("U.S. GAAP"). The Company's significant accounting policies include the
following:
(A) PREMIUM REVENUES
Premiums written are estimated and recognized at the inception of the
reinsurance contract, based upon information received from intermediaries and
ceding companies. The Company compares estimated written premiums to actual
premiums as reported by ceding companies on a periodic basis. The timeliness and
frequency of ceding company reports vary considerably by ceding company, line of
business and geographic area, which means that the actual ultimate premium
written may not be known with certainty for prolonged periods. Differences
between such estimates and actual amounts as reported by ceding companies are
recorded in the period in which the actual amounts are determined.
The reinsurance contracts entered into by the Company are primarily of
short duration. Premiums written are recognized as earned over the coverage
period in proportion to the amount of protection provided. Unearned premium
reserves are established to cover the unexpired contract period.
<PAGE> 31
(B) RESERVE FOR LOSSES AND LOSS EXPENSES
The reserve for unpaid losses and loss adjustment expenses includes an estimate
of reported case reserves and an estimate for losses incurred but not reported.
Case reserves are estimated based on ceding company reports and other data
considered relevant to the estimation process. The liability for losses incurred
but not reported is based to a large extent on the expectations of ceding
companies about ultimate loss ratios at the inception of the contracts,
supplemented by industry experience and the Company's specific historical
experience where available. As the Company has limited specific historical
experience on a significant number of its programs on which to base its estimate
of losses incurred but not reported, its reliance on ceding company expectations
and industry experience is necessarily increased, which increases the
uncertainty involved in the loss estimation process.
The reserves as established by management are reviewed periodically, and
adjustments are made in the periods in which they become known. Although
management believes that an adequate provision has been made for the liability
for losses and loss expenses, based on all available information, there can be
no assurance that the ultimate losses will not differ significantly from the
amounts provided.
(C) INVESTMENTS
Fixed maturity securities are classified as available for sale and are reported
at estimated fair value. Investments that are available for sale are expected to
be held for an indefinite period but may be sold depending on interest rates and
other considerations. Short-term investments comprise investments with a
maturity greater than 90 days but less than one year and are stated at cost,
which approximates fair value. Strategic investments over which the Company
exercises significant influence are accounted for under the equity method. Other
strategic investments are accounted for at cost. Unrealized investment gains and
losses on fixed maturity securities available for sale, net of applicable
deferred income tax, are reported as a separate component of "accumulated other
comprehensive income". Realized gains or losses on sale of investments are
determined on the basis of average cost. The carrying values of fixed maturities
and strategic investments are adjusted for impairments in value that are
considered to be other than temporary.
(D) DEFERRED ACQUISITION COSTS
Acquisition costs, consisting principally of commissions and brokerage expenses
incurred at the time a contract or policy is issued, are deferred and amortized
over the period in which the related premiums are earned. Deferred policy
acquisition costs are limited to their estimated realizable value based on the
related unearned premiums, anticipated claims and claim expenses and anticipated
investment income.
(E) REINSURANCE PREMIUMS CEDED
Reinsurance premiums ceded are reported as prepaid reinsurance premiums and
amortized over the respective contract or policy periods in proportion to the
amount of insurance protection provided. Commissions on reinsurance ceded will
be deferred over the terms of the contracts of reinsurance to which they relate
and amortized in proportion to the amount of insurance protection provided.
(F) MANAGEMENT FEE REVENUE
Management fee revenue consists primarily of fees earned as compensation for
underwriting and managing the reinsurance portfolio on behalf of the Company's
co-reinsurers. These fees are estimated and recognized at the inception of the
contracts with the co-reinsurers. In addition, adjustments to management fees
and profit commission arising from underwriting results for 1997 and prior
years, when the Company operated as a reinsurance management company, are
estimated and accrued.
(G) INCOME TAXES
The Company and its subsidiaries file income tax returns as required by the laws
of each country in which it has operations. The Company accounts for income tax
expenses and liabilities under the asset and liability method in accordance with
Statement of Financial Accounting Standards Board ("SFAS") No. 109, "Accounting
for Income Taxes." Deferred income taxes arise from the recognition of temporary
differences between income reported for financial statement purposes and income
for income tax purposes. These deferred taxes are measured by applying currently
enacted tax rates. In addition, SFAS No. 109 requires the recognition of future
benefits, such as for net operating loss carryforwards, to the extent that
realization of such benefits is more likely than not.
<PAGE> 32
(H) FOREIGN CURRENCY TRANSLATION
The functional and reporting currency of the Company is U.S. dollars. Foreign
currency receivables or payables that are denominated in a currency other than
U.S. dollars are translated into U.S. dollars at the rates of exchange in effect
at the balance sheet date. Revenues and expenses are translated into U.S.
dollars using weighted average exchange rates for the period. The resulting
exchange gains or losses are included in the results of operations. Exchange
gains and losses related to the translation of investments available for sale
are included in the net unrealized appreciation (depreciation) of investments,
net of deferred income taxes, as a separate component of "accumulated other
comprehensive income."
Assets and liabilities related to foreign operations are translated into
U.S. dollars at the exchange rate in effect at the balance sheet date; revenues
and expenses are translated into U.S. dollars using weighted average exchange
rates for the period. Gains and losses resulting from translating foreign
currency financial statements, net of deferred income taxes, are excluded from
income and included as a separate component of "accumulated other comprehensive
income."
(I) EARNINGS PER SHARE
Basic earnings per share are computed by dividing net income by the weighted
average number of common shares. Diluted earnings per common share reflect the
maximum dilution that would have resulted from the exercise of stock options and
warrants to purchase common shares. Diluted earnings per common share are
computed by dividing net income by the weighted average number of common shares
and all dilutive securities.
(J) STOCK-BASED COMPENSATION
SFAS No. 123, "Accounting for Stock-Based Compensation" defines a fair value
based method of accounting for stock-based employee compensation plans. Under
SFAS No. 123, companies are encouraged, but are not required, to adopt the fair
value method for all employee awards granted. Companies are permitted to account
for such transactions under Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees," but must disclose in a note to the
financial statements, pro forma net income and earnings per share as if SFAS No.
123 had been applied. The Company accounts for stock-based compensation under
APB No. 25 and provides the fair value method disclosures required by SFAS No.
123.
(K) CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash and bank deposits with original
maturities of 90 days or less.
(L) ESTIMATES
The preparation of financial statements in accordance with U.S. generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period as
well as the disclosure of such amounts. Actual results could materially differ
from those estimates and assumptions.
(M) ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" (SFAS 133). SFAS 133, which is effective in the first
quarter of 2000, establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
financial instruments and contracts, and for hedging activities. The Company has
not completed its analysis of the expected future impact of SFAS 133.
<PAGE> 33
3. INVESTMENTS
(A) FIXED MATURITIES
The amortized cost, fair value and gross unrealized gains and losses of fixed
maturity investments as of December 31, 1998 and 1997 are presented in the
tables below:
<TABLE>
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized Fair
As of December 31, 1998 Cost Gains Losses Value
- ------------------------------------------------------------------------------------------------------------------------------------
U.S. dollars in thousands
<S> <C> <C> <C> <C>
Corporate securities $138,447 $ 307 $ 27 $138,727
U.S. treasury securities 31,887 108 297 31,698
Mortgage-backed securities/Asset-backed securities 9,230 15 13 9,232
Obligations of states and political subdivisions 24,231 416 -- 24,647
Foreign currency debt securities 7,794 289 -- 8,083
-------- -------- -------- --------
Total $211,589 $ 1,135 $ 337 $212,387
======== ======== ======== ========
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized Fair
As of December 31, 1997 Cost Gains Losses Value
- ------------------------------------------------------------------------------------------------------------------------------------
U.S. dollars in thousands
<S> <C> <C> <C> <C>
Fixed maturities - available for sale
U.S. treasury securities and obligations of
U.S. government agencies and corporations $218,694 $ 173 $ -- $218,867
-------- -------- -------- --------
Total $218,694 $ 173 $ -- $218,867
======== ======== ======== ========
</TABLE>
(B) MATURITY DISTRIBUTION
The amortized cost and fair value of fixed maturities by contractual maturity
are shown in the following table:
<TABLE>
<CAPTION>
Amortized Fair
As of December 31, 1998 Cost Value
- --------------------------------------------------------------------------------
U.S. dollars in thousands
<S> <C> <C>
Fixed maturities - available for sale
Due in one year or less $ 10,512 $ 10,525
Due after one year through five years 131,337 131,930
Due after five years through ten years 30,030 30,023
Due after ten years 30,480 30,677
Mortgage-backed securities/Asset-backed securities 9,230 9,232
-------- --------
Total $211,589 $212,387
======== ========
</TABLE>
(C) REALIZED GAINS AND LOSSES
Proceeds from the sales of investments available for sale for the year ended
December 31, 1998 were $445.3 million. Realized investment gains and losses for
the year ended December 31, 1998 were as follows:
<TABLE>
<CAPTION>
1998
- --------------------------------------------------------------------------------
U.S. dollars in thousands
<S> <C>
Gross realized gains $ 2,165
Gross realized losses (3)
-------
Total net realized gains $ 2,162
=======
</TABLE>
No gains or losses were realized during 1997 or 1996.
<PAGE> 34
(D) CHANGE IN NET UNREALIZED GAINS ON INVESTMENTS
<TABLE>
<CAPTION>
As of December 31, 1998 1997 1996
- --------------------------------------------------------------------------------
U.S. dollars in thousands
<S> <C> <C> <C>
Change in unrealized gains on investments,
net of deferred taxes, included in
other comprehensive income:
Fixed Maturities $ 2,787 $ 173 $ --
Deferred taxes (172) (3) --
------- ------- -------
Total $ 2,615 $ 170 $ --
======= ======= =======
</TABLE>
(E) NET INVESTMENT INCOME
The components of net investment income are presented in the table below:
<TABLE>
<CAPTION>
Years Ended December 31, 1998 1997 1996
- --------------------------------------------------------------------------------
U.S. dollars in thousands
<S> <C> <C> <C>
Interest on fixed maturities $ 12,813 $ 438 $ --
Interest on short-term investments 440 71 --
Interest on cash and cash equivalents 294 -- --
Other 36 141 186
-------- -------- --------
Total investment income 13,583 650 186
Investment expenses (653) (52) --
-------- -------- --------
Net investment income $ 12,930 $ 598 $ 186
======== ======== ========
</TABLE>
4. STRATEGIC INVESTMENTS
Strategic investments represents equity investments in, and loans to,
reinsurance-related enterprises, ceding companies or distribution channels that
are expected to generate or secure additional profitable business for the
Company. Equity investments are $2.0 million while loans totalling $3.9 million
are extended to three companies. The loans bear interest at rates between 6% and
9% and are repayable between one and five years. The fair value of strategic
investments approximates their carrying value.
5. MANAGEMENT FEES RECEIVABLE
Management fees receivable represents management fee and related revenues that
are primarily due from the reinsurers participating in the reinsurance pools and
from co-reinsurers to whom a portion of the Company's gross managed premium is
allocated. Management fees receivable at December 31, 1998 and 1997 consist of
the following:
<TABLE>
<CAPTION>
1998 1997
- --------------------------------------------------------------------------------
<S> <C> <C>
Management fees on 1997 and prior reinsurance pools $1,542 $3,259
Fees from co-reinsurers 1,062 --
Consultancy fees 560 --
------ ------
$3,164 $3,259
====== ======
</TABLE>
6. DEFERRED ACQUISITION COSTS
Activity in deferred acquisition costs for the years ended December 31, 1998 and
1997 is summarized as follows:
<TABLE>
<CAPTION>
Years Ended December 31, 1998 1997
- --------------------------------------------------------------------------------
U.S. dollars in thousands
<S> <C> <C> <C>
Balance at January 1 $ 4,147 $ --
Acquisition costs incurred 60,192 8,840
Amortization of acquisition costs (26,714) (4,693)
-------- --------
Net change in deferred acquisition costs asset 33,478 4,147
-------- --------
Balance at December 31 $ 37,625 $ 4,147
======== ========
</TABLE>
<PAGE> 35
7. LOSSES AND LOSS EXPENSES
Activity in the reserve for unpaid losses and loss expenses for the years ended
December 31, 1998 and 1997 is summarized as follows:
<TABLE>
<CAPTION>
Years Ended December 31, 1998 1997
- --------------------------------------------------------------------------------
U.S. dollars in thousands
<S> <C> <C>
Balance at January 1 $ 7,846 $ --
Incurred related to:
Current year 60,912 7,449
Prior year 452 --
------- -------
Total incurred losses and loss expenses 61,364 7,449
------- -------
Paid related to:
Current year 22,568 --
Prior year 5,024 --
------- -------
Total paid losses and loss expenses 27,592 --
------- -------
Net balance at December 31 41,618 7,449
Plus reinsurance recoverable on incurred losses 2,761 397
------- -------
Balance at December 31 $44,379 $ 7,846
======= =======
</TABLE>
8. INCOME TAXES
Under current Bermuda law, the Company is not required to pay taxes in Bermuda
on either income or capital gains. Provision for income taxes consists of
corporate and other applicable income taxes payable in the various jurisdictions
in which the Company conducts its business including Germany, Ireland, Canada
and the United Kingdom. The components of income taxes for the years presented
are as follows:
<TABLE>
<CAPTION>
Years Ended December 31, 1998 1997 1996
- --------------------------------------------------------------------------------
U.S. dollars in thousands
<S> <C> <C> <C>
Current tax expense
Bermuda $ -- $ -- $ --
Foreign 1,435 4 157
------- ------- -------
Total current tax expense 1,435 4 157
Total deferred tax (benefit) (173) (573) (1)
------- ------- -------
Total income tax expense (benefit) $ 1,262 $ (569) $ 156
======= ======= =======
</TABLE>
The actual income tax expense attributable to income for the three years in
the period ended December 31, 1998 is based on the statutory tax rates in the
Company's taxable jurisdictions, which range from 0% to approximately 50%.
<TABLE>
<CAPTION>
Years Ended December 31, 1998 1997 1996
- --------------------------------------------------------------------------------
U.S. dollars in thousands
<S> <C> <C> <C>
Computed "expected tax expense" $ -- $ -- $ (4)
Tax effect of foreign taxes 1,262 (569) 160
------ ------ ------
Total income tax expense (benefit) $1,262 $ (569) $ 156
====== ====== ======
</TABLE>
Deferred income taxes reflect the tax effect of the temporary differences
between the value of assets and liabilities for financial statement purposes and
such values as measured by the tax laws and regulations. The principal items in
the net deferred income tax asset (liability) are as follows:
<TABLE>
<CAPTION>
Years Ended December 31, 1998 1997
- --------------------------------------------------------------------------------
U.S. dollars in thousands
<S> <C> <C>
Deferred tax assets
Net operating loss carryforward $ 1,874 $ 683
Other assets 470 161
------- -------
Gross deferred tax assets 2,344 844
Less: valuation allowance (976) --
======= =======
Deferred tax assets after valuation allowance $ 1,368 $ 844
------- -------
Deferred tax liabilities
Unrealized investment gains (164) (46)
Other liabilities (361) (10)
------- -------
Total deferred tax liabilities $ (525) $ (56)
------- -------
Net deferred tax asset $ 843 $ 788
======= =======
</TABLE>
Realization of the deferred tax asset is dependent on generating sufficient
taxable income in the future. During 1998, the Company recorded a valuation
allowance of $976 thousand to reduce its deferred tax asset to estimated
realizable value. The Company has tax loss carryforwards included in the
calculation of the deferred tax asset as of December 31, 1998, of $3.4 million
available to offset future foreign taxable income. Such tax loss carryforwards
currently do not have an expiration date.
9. RETROCESSIONS
The Company utilizes retrocessional agreements to reduce its exposure to large
claims and catastrophic loss occurrences. These agreements provide for recovery
from retrocessionaires of a portion of the losses and loss expenses under
certain circumstances. They do not discharge the primary liability of the
Company. In the event retrocessionaires were unable to meet their obligations
under the retrocession agreements, the Company would not be able to realize the
full value of the reinsurance recoverable balances. The Company believes that it
has minimized the credit risk with respect to its retrocessionaires by
monitoring its retrocessionaires and diversifying its retrocessions.
<PAGE> 36
Losses and loss expenses incurred and earned premiums as reported in the
statement of operations are after deduction for retrocessions. Written and
earned premiums and losses incurred for the years ended December 31, 1998 and
1997 are comprised of the following:
<TABLE>
<CAPTION>
Years Ended December 31, 1998 1997
- --------------------------------------------------------------------------------
U.S. dollars in thousands
<S> <C> <C>
Premiums written:
Assumed $ 199,872 $ 26,143
Retroceded (4,294) (751)
--------- ---------
Net premiums written $ 195,578 $ 25,392
========= =========
Premiums earned:
Assumed $ 100,985 $ 13,862
Retroceded (2,144) (451)
--------- ---------
Net premiums earned $ 98,841 $ 13,411
========= =========
Losses and loss expenses:
Assumed $ 63,728 $ 7,846
Retroceded (2,364) (397)
--------- ---------
Net losses and loss expenses $ 61,364 $ 7,449
========= =========
</TABLE>
10. EARNINGS PER SHARE
RECONCILIATION OF NUMERATORS AND DENOMINATORS
The following is a reconciliation of the numerators and denominators of the
basic and diluted earnings per share computations for income from continuing
operations:
<TABLE>
<CAPTION>
Gain Shares Per Share
Year Ended December 31, 1998 (Numerator) (Denominator) Amount
- -------------------------------------------------------------------------------
U.S. dollars in thousands
except share and per share data
<S> <C> <C> <C>
BASIC EARNINGS PER SHARE
Gain allocable to common shareholders $ 14,522 13,923,799 $ 1.04
Effect of dilutive securities:
Class A Warrants -- 100,401 --
Class B Warrants -- 34,143 --
Director and Employee Options -- 18,100 --
DILUTED EARNINGS PER SHARE
---------- ---------- ----------
Gain allocable to common shareholders $ 14,522 14,076,443 $ 1.04
========== ========== ==========
</TABLE>
<TABLE>
<CAPTION>
Gain Shares Per Share
Year Ended December 31, 1997 (Numerator) (Denominator) Amount
- --------------------------------------------------------------------------------
U.S. dollars in thousands
except share and per share data
<S> <C> <C> <C>
BASIC EARNINGS PER SHARE
Loss allocable to common shareholders $ (5,096) 1,238,757 $ (4.11)
Effect of dilutive securities:
Class A Warrants -- -- --
Class B Warrants -- -- --
Director and Employee Options -- -- --
DILUTED EARNINGS PER SHARE
--------- --------- ---------
Loss allocable to common shareholders $ (5,096) 1,238,757 $ (4.11)
========= ========= =========
</TABLE>
Class A Warrants to purchase 1,381,200 common shares at $20 per share and
options to purchase up to 815,428 common shares, issued at exercise prices
between $14.76 and $26.50, were outstanding as of December 31, 1998. For the
year ending December 31, 1997 the effect of dilutive securities was not included
in the computation of diluted earnings per share as required by SFAS 128,
"Earnings per Share" because, as the Company incurred a loss for the year, the
effect of these securities was antidilutive.
<PAGE> 37
11. COMMITMENTS AND CONTINGENCIES
(A) EMPLOYMENT CONTRACTS
The Company has entered into various employment contracts with terms of up to
five years that have total minimum commitments of $7 million, excluding any
performance bonuses that are determined by the Board of Directors of the
Company. The contracts include various noncompete clauses following termination
of employment.
(B) LEASE COMMITMENTS
The Company and its subsidiaries have various lease obligations. Rental expenses
are amortized on the straight-line basis over the term of the lease. Total
rental expense was approximately $398 thousand, $286 thousand and $295 thousand
for the years ended December 31, 1998, 1997 and 1996, respectively.
The future minimum commitments under operating leases and employment
contracts are as follows:
<TABLE>
<CAPTION>
Lease Employment
Years Ending December 31, Commitments Commitments Total
- --------------------------------------------------------------------------------
U.S. dollars in thousands
<S> <C> <C> <C>
1999 $ 476 $2,514 $2,990
2000 487 2,316 2,803
2001 349 1,130 1,479
2002 72 763 835
2003 -- 253 253
------ ------ ------
Total $1,384 $6,976 $8,360
====== ====== ======
</TABLE>
(C) LETTERS OF CREDIT
Unsecured Letters of Credit in the amount of $23.6 million have been issued in
favor of ceding companies.
(D) PENSION OBLIGATIONS
Certain subsidiaries are obligated to make defined contributions to pension
plans for their employees. As of December 31, 1998, there was an outstanding
liability for pension contributions of $207 thousand. There was no outstanding
liability for pension contributions as of December 31, 1997 and 1996. Pension
contribution expense was $143 thousand, $29 thousand, and $20 thousand for the
years ended December 31, 1998, 1997 and 1996, respectively.
12. FIDUCIARY ASSETS AND LIABILITIES
As part of its prior underwriting pool management services, the Company collects
premiums and pays claims on behalf of the pool participants. In addition to fees
received for the underwriting services, the Company also earns interest income
on funds it is authorized to hold in accordance with the underwriting management
agreements between the Company and the pool participants. The Company is
authorized to retain 25% of gross premiums as a claims fund held in bank
accounts having trustee status with any interest accruing to such balances being
credited to the Company on a quarterly basis.
13. WARRANTS
In connection with the Direct Sales, the Company issued Class A Warrants to
purchase up to 1,381,200 common shares and Class B Warrants to purchase up to
1,381,200 common shares if certain performance criteria are satisfied. The Class
A Warrants are vested and are exercisable at $20 per share at any time prior to
December 2007.
Twenty percent of the Class B Warrants are available for vesting during
each of the first five years following the closing date of the IPO, and will
vest only if, for any 20 consecutive trading days during the one-year vesting
period, the percentage change in the market price of the common shares since the
closing date of the IPO exceeds the percentage change in the Wilshire 5000 Stock
Price Index by at least 500 basis points. The Class B Warrants are exercisable
for a period of 10 years from the date of vesting. The exercise price per Common
Share is $20 and will be reduced by $1.50 on September 1, 2001.
As of December 31, 1998, 276,240 of the Class B Warrants are vested and are
exercisable.
For the year ended December 31, 1997, in accordance with the Emerging
Issues Task Force Consensus 96-18, "Accounting for Equity Instruments that are
Issued to Other Than Employees for Acquiring, or in Conjunction with Selling,
Goods and Services," the Company recorded compensation expense of $3.6 million
paid to a related party. This expense was reflected as a charge to the statement
of operations, and as an increase to additional paid-in capital.
<PAGE> 38
14. STOCK-BASED COMPENSATION
(A) EMPLOYEE STOCK OPTION PLAN
On December 12, 1997, the Company adopted the 1997 Employees Stock Option Plan
(the "Stock Option Plan") under which employees of the Company and its
subsidiaries are eligible to participate. The Stock Option Plan is administered
by the Board of Directors. Subject to the provisions of the Stock Option Plan,
the Board of Directors has sole discretionary authority to interpret the Stock
Option Plan and to determine the terms and conditions of the award.
The exercise price of the option will be determined by the Board of
Directors when the options are granted. Options granted under the Stock Option
Plan are freely assignable subject to certain limitations. The Company has
reserved 2,000,000 common shares for issuance under the Stock Option Plan.
As of December 31, 1998, options to purchase a total of 609,000 shares of
common stock were granted to officers and employees of the Company. Options
granted under the Employee Stock Option Plan vest at 25% at the date of grant
and at 25% on each of the second, third and fourth anniversaries of the date of
grant. All options are exercisable at fair market value of the stock at the date
of the grant and expire 10 years after the date of the grant.
(B) DIRECTORS' STOCK OPTION PLAN
On December 12, 1997, the Company adopted the ESG Re Limited Non-management
Directors' Compensation and Option Plan (the "Directors' Plan"), under which
non-management directors joining the Board of Directors within one year of the
closing of the Offering shall receive stock options to purchase up to 10,000
common shares. Options granted on December 12, 1997, the date of the IPO, were
granted at the IPO price of $20 per share. In addition, the Directors' Plan
provides for automatic annual awards of options to purchase up to 5,000 common
shares (or, in each case, a lesser amount prorated to the extent the
participating director did not serve on the Board of Directors for the entire
year preceding the relevant annual shareholders' meeting), at an exercise price
per share equal to the then market price per share to be made to non-management
directors on the date of each successive annual shareholders' meeting. In
addition, each non-management director will receive fees for services as a
member of the Board of Directors and its committees, in amounts determined by
the Board of Directors, to be paid in a combination of cash and common shares,
as determined by the Board of Directors, unless otherwise elected pursuant to
the terms of the Directors' Plan, as described below. In any year, in lieu of
such stock and cash payment, a Director may elect to receive all or a portion of
such fees in options or to defer all or a portion of such fees. If a director
elects to receive options, the director will receive options for common shares
equal to two times the fees that would otherwise be payable. If the director
elects to defer the receipt of the fees, he will receive deferred compensation
indexed to the greater of (i) the total return on the common shares; or (ii) the
one-year U.S. Treasury bill rate. Deferred compensation will be paid in cash at
the time elected by the directors in accordance with the terms of the Directors'
Plan. Shares granted under the Directors' Plan will be nontransferable for six
months after receipt. The Company has reserved 1,000,000 common shares for
issuance under the Directors' Plan.
All non-management directors have elected to receive their fees as options
to purchase shares. As a result, a total of 206,428 shares of common stock have
been granted as stock options as of December 31, 1998. Compensation expense of
$347 thousand and $39 thousand was recorded for the years ending December 31,
1998 and 1997, respectively.
Options granted under the Directors' Plan vest 100% at the date of grant.
All options are exercisable at fair market value of the stock at the date of
grant and expire 10 years after the date of grant.
A summary of the status of the Company's outstanding stock options as of
December 31, 1998 and 1997 is presented below:
<TABLE>
<CAPTION>
1998 1997
-------------------------- ----------------------------
Weighted Average Weighted Average
Shares Exercise Price Shares Exercise Price
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Outstanding at January 1 469,714 $ 20.00 -- --
Granted 355,214 $ 24.50 469,714 $ 20.00
Exercised -- -- -- --
Forfeited (9,500) $ 25.13 -- --
------- ------- -------- -------
Outstanding at December 31 815,428 $ 21.90 469,714 $ 20.00
------- ------- -------- -------
Options exercisable at December 31 358,678 $ 22.37 189,214 $ 20.00
------- ------- -------- -------
Average fair value of options granted
during the year $ 6.73 $ 7.00
======= =======
</TABLE>
The fair value of each option grant was estimated using the Black/Scholes
option pricing model with the following assumptions: (i) dividend yield of
1.74%; (ii) expected volatility of 35%; (iii) risk-free rate of 4.8%; and (iv)
expected life of 8 years.
Had the compensation expense for the Company's stock-based compensation
plans been determined based on the fair value at the grant dates for awards
under those plans consistent with the method described in SFAS No. 123, the
Company's net income and earnings per share would have been adjusted to the pro
forma amounts indicated below:
<TABLE>
<CAPTION>
Years Ended December 31, 1998 1997
- --------------------------------------------------------------------------------
U.S. dollars in thousands
except share and per share data
<S> <C> <C>
Net gain (loss)
As reported $ 14,522 $ (5,096)
Pro forma 12,526 (5,409)
---------- ---------
Earnings (loss) per share
As reported $ 1.04 $ (4.11)
Pro forma 0.90 (4.37)
========== =========
</TABLE>
15. RELATED PARTIES
In 1997, the Company entered into an agreement with Head Asset Management L.L.C.
("Head Asset Management"), an affiliate of Head & Company L.L.C. ("Head
Company"), relating to the provision of investment management services. The
Chairman of the Board of Directors is a Managing Member of Head Company.
Pursuant to this agreement, which is subject to the Company's investment
guidelines and other restrictions, the Company will pay Head Asset Management a
fee equal to the sum of (i) 0.25% per annum of the first $200 million of assets
under management; and (ii) 0.15% per annum of assets under management in excess
of $200 million. The Company incurred expenses of $549 thousand and $45 thousand
under this agreement for the years ended December 31, 1998 and 1997,
respectively.
In 1997, Head Company provided support and assistance in connection with
the planning, structuring and formation of the Company, as well as capital
raising in connection with the Direct Sales and IPO. For advisory services
rendered by Head Company, the Company incurred fees and expenses of $2.7 million
of which $2.5 million was paid in January 1998. These expenses are reflected as
a reduction of additional paid-in capital. In January 1998, the Company entered
into an agreement with Head Company to provide financial advisory services as
required by the Company for a monthly fee of $50 thousand. Under this agreement,
the Company incurred fees and direct expenses of $378 thousand. The agreement
was terminated in the second quarter of 1998.
Certain former shareholders of ESG Germany who participated in the
Formation have agreed to indemnify ESG Germany for certain contingent
liabilities applicable to activity prior to 1997. Management believes that the
likelihood of incurring a loss related to any of those contingent liabilities is
remote.
16. SEGMENT INFORMATION
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information," requires that an enterprise disclose information about its
operating segments. The Company considers its reinsurance activities to
constitute a single operating segment on the basis that such activities are
monitored and evaluated primarily on a companywide basis. Investments are held
in support of reinsurance activities and are considered to be a part of this
single segment.
However, the following table provides summary financial information by the
Company's lines of business and geographic regions. Revenues are allocated
geographically on the basis of the location of the legal entity that retains the
reinsurance risk.
<TABLE>
<CAPTION>
Personal Special
Year Ended December 31, 1998 Medical Accident Risk Credit Life Total
- ------------------------------------------------------------------------------------------------------------------------------------
U.S. dollars in thousands
<S> <C> <C> <C> <C> <C> <C>
Gross premiums written $ 119,157 $ 52,254 $ 5,120 $ 12,346 $ 10,995 $ 199,872
Net premiums written 117,353 50,814 4,943 11,910 10,558 195,578
Net premiums earned 40,875 46,038 2,571 4,856 4,501 98,841
Losses and loss expenses 24,646 29,003 859 3,448 3,408 61,364
Acquisition costs 14,241 10,207 906 837 523 26,714
Operating costs 3,584 4,036 228 420 534 8,802
--------- --------- --------- --------- --------- ---------
Net underwriting income (loss) $ (1,596) $ 2,792 $ 578 $ 151 $ 36 $ 1,961
========= ========= ========= ========= ========= =========
<CAPTION>
Personal Special
Year Ended December 31, 1998 Medical Accident Risk Credit Life Total
- ------------------------------------------------------------------------------------------------------------------------------------
U.S. dollars in thousands
<S> <C> <C> <C> <C> <C> <C>
Gross premiums written $ 9,989 $ 9,357 $ 396 $ 6,401 $ -- $ 26,143
Net premiums written 9,937 8,723 376 6,356 -- 25,392
Net premiums earned 5,964 3,778 243 3,426 -- 13,411
Losses and loss expenses 3,624 1,907 139 1,779 -- 7,449
Acquisition costs 2,099 1,303 85 1,206 -- 4,693
--------- --------- --------- --------- --------- ---------
Net underwriting income $ 241 $ 568 $ 19 $ 441 $ -- $ 1,269
========= ========= ========= ========= ========= =========
<CAPTION>
Years Ended December 31, 1998 1997
- ------------------------------------------------------------------------------------------------------------------------------------
U.S. dollars in thousands
<S> <C> <C>
Revenue earned:
Bermuda $ 43,839 $ 13,763
Ireland 59,281 --
Germany 8,812 3,989
Other 3,895 87
--------- ---------
Total revenue earned $ 115,827 $ 17,839
========= =========
</TABLE>
<PAGE> 39
17. SIGNIFICANT CLIENTS
For the year ended December 31, 1998, one significant client relationship
contributed $25.1 million to total revenue. For the year ended December 31,
1997, three significant client relationships contributed $3.6 million, $2.6
million and $2.4 million to total revenue. For the year ended December 31, 1996,
one client contributed $774 thousand.
18. STATUTORY REQUIREMENTS AND DIVIDEND RESTRICTIONS
Under Bermuda law, the Company is prohibited from declaring or paying a dividend
if such payment would reduce the realizable value of its assets to an amount
less than the aggregate value of its liabilities, issued share capital (common
share capital) and share premium (additional paid-in capital) accounts.
Under the Bermuda Insurance Act, 1978, amendments thereto and Related
Regulations, ES Bermuda is required to maintain certain measures of solvency and
liquidity. For the years ended December 31, 1998 and 1997, these requirements
have been met. The statutory capital and surplus of ES Bermuda was $137.1
million and $101.5 million and the minimum required statutory capital and
surplus was $8.7 million and $4.1 million as of December 31, 1998 and 1997,
respectively. The minimum required level of liquid assets was $55.2 million and
$22.3 million with actual liquid assets of $210.7 million and $81.1 million as
of December 31, 1998 and 1997, respectively.
19. YEAR 2000 ISSUE
The Year 2000 Issue relates to the ability of computer systems to properly
interpret date information for the year 2000 and beyond. In January 1998, the
Company initiated an enterprise-wide project to address Year 2000 issues with
respect to the Company's computer software and information technology systems.
The initiative has as its focus two distinct areas that include Year 2000
compliance of the Company's software, systems and technology platforms and the
evaluation of the Year 2000 preparedness of significant third parties with whom
the Company conducts business, including vendors and customers.
The Company has substantially completed its assessment of Company software
and systems and has adopted a plan to implement compliant components and to
develop a disaster recovery plan, targeted to be substantially complete by the
end of the second quarter 1999. The Company estimates that through December
1998, the remediation and validation efforts are approximately 60% complete,
with immaterial incremental costs incurred thus far as a result of usage of
internal staff. Remaining testing and conversion efforts also are expected to be
conducted primarily by internal staff; however, limited third-party assistance
during the first two quarters of 1999 may be utilized. No significant
third-party costs are anticipated. Future costs of remediation are not expected
to have a material impact on the Company's financial position, results of
operations or cash flows, although no assurance can be given in this regard.
The Company's systems do not interface electronically with those of its
customers or clients. As such, the Company's exposure to the Year 2000 Issue
with respect to customers and clients is limited to the possibility that
information supplied by these companies could not be of sufficient quality or
timeliness and therefore could indirectly affect the quality or timeliness of
the Company's own data. The Company is currently communicating with its
significant clients and service providers to assess their vulnerability and
readiness to comply with Year 2000 issues and will address compliance risks with
each new significant vendor.
<PAGE> 40
20. UNAUDITED QUARTERLY FINANCIAL DATA
<TABLE>
<CAPTION>
1998 Operating Data: First Quarter Second Quarter Third Quarter Fourth Quarter
- ------------------------------------------------------------------------------------------------------------------------------------
U.S. dollars in thousands except per share data
<S> <C> <C> <C> <C>
Net premiums written $ 84,156 $ 19,526 $ 53,915 $ 37,981
Net premiums earned 23,219 18,090 26,134 31,398
Management fee revenue 970 229 181 514
Net investment income 3,020 3,211 3,359 3,340
Losses and loss expenses 15,642 11,340 15,940 18,442
Acquisition costs 5,270 4,434 7,324 9,686
Underwriting profit 2,307 2,316 2,870 3,270
Net income (loss) 3,251 3,247 3,994 4,030
========== ========== ========== ==========
Earnings per common share:
Basic net income (loss) per share $ 0.23 $ 0.23 $ 0.29 $ 0.29
Diluted net income (loss) per share 0.23 0.23 0.29 0.29
Weighted average shares outstanding (000's):
Basic 13,924 13,924 13,924 13,924
Diluted 14,374 14,231 13,925 13,926
1997 Operating Data: First Quarter Second Quarter Third Quarter Fourth Quarter
- ------------------------------------------------------------------------------------------------------------------------------------
U.S. dollars in thousands except per share data
<S> <C> <C> <C> <C>
Net premiums written $ -- $ -- $ -- $ 25,392
Net premiums earned -- -- -- 13,411
Management fee revenue 2,378 217 356 879
Net investment income -- 15 6 577
Losses and loss expenses -- -- -- 7,449
Acquisition costs -- -- -- 4,693
Underwriting profit -- -- -- 1,269
Net income (loss) $ 450 $ (252) $ (310) $ (4,984)
========== ========== ========== ==========
Earnings per common share:
Basic net income (loss) per share $ 2.50 $ (1.40) $ (0.40) $ (1.32)
Diluted net income (loss) per share 2.50 (1.40) (0.40) (1.32)
Weighted average shares outstanding (000's): 180 180 783 3,778
---------- ---------- ---------- ----------
Total
</TABLE>
<PAGE> 41
ESGRe Limited
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of ESG Re Limited
We have audited the accompanying consolidated balance sheets of ESG Re Limited
and subsidiaries as of December 31, 1998 and 1997, and the related consolidated
statements of operations, comprehensive income, changes in shareholders' equity
and cash flows for each of the three years in the period ended December 31,
1998. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. 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, such consolidated financial statements present fairly, in
all material respects, the financial position of the Company and its
subsidiaries as of December 31, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998, in conformity with accounting principles generally accepted
in the United States of America.
DELOITTE & TOUCHE
Chartered Accountants
Hamilton, Bermuda
March 8, 1999
ESGRE LIMITED
CORPORATE DIRECTORY
53
<PAGE> 42
BOARD OF DIRECTORS EXECUTIVE AND
SENIOR MANAGEMENT
JOHN C HEAD III(a)
Chairman of the Board
Managing Member
Head & Company L.L.C.
New York, New York
WOLFGANG M. WAND
Managing Director and
Chief Executive Officer
ESG Re Limited
Hamilton, Bermuda
STEVEN H. DEBROVNER
Chief Underwriting and
Marketing Officer
ESG Re Limited
Hamilton, Bermuda
KENNETH P. MORSE
Managing Director
MIT Entrepreneurship Center
and Senior Lecturer
MIT Sloan School of Management
Cambridge, Massachusetts
DAVID L. NEWKIRK(a),(b)
Vice President
Booz-Allen & Hamilton
International (U.K.) Ltd.
London, England
WILLIAM J. POUTSIAKA(b)
President and
Chief Executive Officer
Arkwright Mutual Insurance Company
Waltham, Massachusetts
EDWARD A. TILLY(a),(b)
Former Chairman
and Chief Executive
Consolidated Financial
Insurance Group, Ltd.
London, England
ESG RE LIMITED
WOLFGANG M. WAND
Managing Director
and Chief Executive Officer
STEVEN H. DEBROVNER
Chief Underwriting and
Marketing Officer
JOAN H. DILLARD
Chief Financial Officer
MICHAEL S. NUENKE
Treasurer
CORMAC G. TREACY
Controller
MARGARET L. WEBSTER
General Counsel and Secretary
ACCENT EUROPE
INSURANCE COMPANY
EDEL M. BOLGER
Managing Director
ES ASIA PACIFIC
DARRYL S. GUMM
Vice President
ES LATIN AMERICA
RAFAEL LA-ROTTA
President
ES NORTH AMERICA
RENATE M. NELLICH
President and
Chief Executive Officer
ES RUCKVERSICHERUNG
DR. JUR. FRANZ GORI
Executive Director
GERHARD JURK
Executive Director
ESG U.K.
ANDREW W. APPS
Managing Director
SPORTSECURE
PATRICK GORLING
Managing Director
(a) Member of the Compensation Committee
(b) Member of the Audit Committee
<PAGE> 43
ESGRE LIMITED
BOARDS OF DIRECTORS, MAJOR SUBSIDIARY COMPANIES
EUROPEAN SPECIALTY
REINSURANCE (BERMUDA) LIMITED
WOLFGANG M. WAND
Member of the Board
ADRIAN LEE-EMERY
Member of the Board
EUROPEAN SPECIALTY
REINSURANCE (IRELAND) LIMITED
WOLFGANG M. WAND
Member of the Board
WILLIAM A. QUIRKE
Member of the Board
MICHAEL J. WALSH
Member of the Board
ACCENT EUROPE
INSURANCE COMPANY LIMITED
EDEL M. BOLGER
Member of the Board
DR. JUR. FRANZ GORI
Member of the Board
PATRICK GORLING
Member of the Board
WILLIAM A. QUIRKE
Member of the Board
MICHAEL J. WALSH
Member of the Board
EUROPEAN SPECIALTY GROUP
(UNITED KINGDOM) LIMITED
ANDREW W. APPS
Managing Director, U.K.
EUROPEAN SPECIALTY
Group Holding AG
WOLFGANG M. WAND
Chairman
YVES FORESTIER
Member of the Board
HARALD HERMANN
Member of the Board
EUROPEAN SPECIALTY
RUCKVERSICHERUNG AG
DR. JEAN CLAUDE MAYOR
Chairman
DR. JUR. HANS MOSER
Deputy Chairman
JURGEN GORLING
Member of the Board
Design by Addison www.addison.com This annual report was printed on recycled
paper.
ESGRE LIMITED
SHAREHOLDER INFORMATION
SHAREHOLDERS MEETING
The Annual General Meeting will be held on May 7, 1999 at 11:00 a.m.
at the Waterloo House,
100 Pitts Bay Road,
Pembroke, Bermuda.
INDEPENDENT ACCOUNTANTS
Deloitte & Touche
Corner House
Church & Parliament Streets
Hamilton, Bermuda
COUNSEL
PAUL, WEISS, RIFKIND,
WHARTON & GARRISON
1285 Avenue of the Americas
New York, New York
APPLEBY, SPURLING & KEMPE
Cedar House
41 Cedar Avenue
Hamilton, Bermuda
MARKET INFORMATION
ESG Re Limited common shares are traded over the counter on the Nasdaq National
Market under the symbol ESREF.
STOCK TRANSFER AND
DIVIDEND AGENT
State Street Bank & Trust Company
c/o Equiserve
P.O. Box 8200
Boston, Massachusetts 02266-8200
Shareholder inquiries (800) 426-5523
ADDITIONAL INFORMATION
ESG Re's Annual Report on Form
10-K, as filed with the Securities and Exchange Commission, is available upon
request by writing to the Chief Financial Officer at the
Corporate Headquarters in Bermuda.
55
<PAGE> 44
ESG RE LIMITED
ESG RE LIMITED
16 Church Street
Hamilton, HM 11, Bermuda
Telephone (1 441) 295 2185
Telefax (1 441) 292 1143
EUROPEAN SPECIALTY
REINSURANCE
(BERMUDA) LIMITED
16 Church Street
Hamilton, HM 11, Bermuda
Telephone (1 441) 295 2185
Telefax (1 441) 292 1143
EUROPEAN SPECIALTY
REINSURANCE
(IRELAND) LIMITED
3rd Floor, 12/13 Exchange Place
I.F.S.C., Dublin 1
Telephone (353 1) 612 6550
Telefax (353 1) 612 6560
ACCENT EUROPE INSURANCE
COMPANY LIMITED
12/13 Exchange Place
I.F.S.C., Dublin 1
Telephone (353 1) 612 6580
Telefax (353 1) 612 6560
EUROPEAN SPECIALTY
RUCKVERSICHERUNG AG
Stadthausbrucke 1-3
Hamburg, 20355 Germany
Telephone (49 40) 36 98 860
Telefax (49 40) 36 98 86 69
EUROPEAN SPECIALTY
(NORTH AMERICA) LIMITED
141 Adelaide Street West
Toronto, M5H 3L2, Canada
Telephone (1 416) 864 7443
Telefax (1 416) 864 9615
EUROPEAN SPECIALTY
ASIA PACIFIC PTY LIMITED
Suite 2001, 20th Floor
Australia Square
264 George Street
Sydney 2000, Australia
Telephone (61 2) 92 51 5205
Telefax (61 2) 92 41 7000
EUROPEAN SPECIALTY GROUP
(UNITED KINGDOM) LIMITED
25-26 Lime Street
London, EC3M 7HR, England
Telephone (44 171) 220 7422
Telefax (44 171) 220 7593
EUROPEAN SPECIALTY
LATIN AMERICA, INC.
1320 S. Dixie Highway
Suite 375
Coral Gables, Florida 33146
Telephone (305) 668 5102
Telefax (305) 668 5104
SPORTSECURE INSURANCE BROKERS GMBH
Stadthausbrucke 1-3
Hamburg, 20355 Germany
Telephone (49 40) 36 98 86 91
Telefax (49 40) 36 98 86 92
56
<PAGE> 1
EXHIBIT 24.1(B)
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statements of ESG
Re Limited on Form S-8 (File No. 333-40341) and Form S-3 (File No. 333-69519)
of our report dated March 8, 1999, appearing in and incorporated by
reference in this Annual Report on Form 10-K of ESG Re Limited for the year
ended December 31, 1998.
Deloitte & Touche
Chartered Accountants
Hamilton, Bermuda
March 31, 1999
20
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEETS AND CONSOLIDATED FINANCIAL STATEMENTS OF OPERATIONS
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<DEBT-HELD-FOR-SALE> 212,387
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 0
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 218,304
<CASH> 16,942
<RECOVER-REINSURE> 2,761
<DEFERRED-ACQUISITION> 37,625
<TOTAL-ASSETS> 466,373
<POLICY-LOSSES> 44,379
<UNEARNED-PREMIUMS> 111,884
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 0
0
0
<COMMON> 13,924
<OTHER-SE> 230,917
<TOTAL-LIABILITY-AND-EQUITY> 466,373
98,841
<INVESTMENT-INCOME> 12,930
<INVESTMENT-GAINS> 2,162
<OTHER-INCOME> 1,894
<BENEFITS> 61,364
<UNDERWRITING-AMORTIZATION> 26,714
<UNDERWRITING-OTHER> 0
<INCOME-PRETAX> 15,784
<INCOME-TAX> 1,262
<INCOME-CONTINUING> 14,522
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 14,522
<EPS-PRIMARY> 1.04
<EPS-DILUTED> 1.03
<RESERVE-OPEN> 7,846
<PROVISION-CURRENT> 63,673
<PROVISION-PRIOR> 452
<PAYMENTS-CURRENT> 22,568
<PAYMENTS-PRIOR> 5,024
<RESERVE-CLOSE> 44,379
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
