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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period to .
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Commission file number 0-13891.
NAC Re Corp.
(Exact name of registrant as specified in its charter)
Delaware 13-3297840
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
One Greenwich Plaza, Greenwich, CT 06836-2568
(Address of principal executive offices)
(203) 622-5200
(Registrant's telephone number, including area code)
Not Applicable
- --------------------------------------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
<PAGE>
Indicate by a 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 |_|
There were 18,339,261 shares outstanding of the Registrant's Common Stock,
$.10 par value, as of March 31, 1998.
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<PAGE>
NAC RE CORP. AND SUBSIDIARIES
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION PAGE NO.
Independent Accountants' Review Report 3
Consolidated Balance Sheet -
March 31, 1998 and December 31, 1997 4
Consolidated Statement of Income -
Three Months Ended March 31, 1998 and 1997 5
Consolidated Statement of Stockholders' Equity -
Three Months Ended March 31, 1998 and 1997 6
Consolidated Statement of Cash Flows -
Three Months Ended March 31, 1998 and 1997 7
Notes to Consolidated Financial Statements 8-9
Management's Discussion and Analysis
of Financial Condition and Results of Operations 10-15
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 16
Signatures 17
Exhibit 15 18
Exhibit 27 19-20
<PAGE>
INDEPENDENT ACCOUNTANT'S REVIEW REPORT
- --------------------------------------
Board of Directors and Shareholders
NAC Re Corporation
We have reviewed the accompanying consolidated balance sheet of NAC Re
Corporation and subsidiaries as of March 31, 1998, and the related consolidated
statements of income, stockholders' equity and cash flows for the three months
ended March 31, 1998 and 1997. These financial statements are the responsibility
of the Company's management.
We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data, and making inquires of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in
accordance with generally accepted auditing standards, which will be performed
for the full year with the objective of expressing an opinion regarding the
financial statements taken as a whole. Accordingly, we do not express such an
opinion.
Based on our reviews, we are not aware of any material modifications that should
be made to the accompanying consolidated financial statements referred to above
for them to be in conformity with generally accepted accounting principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet of NAC Re Corporation as of December
31, 1997, and the related consolidated statements of income, stockholders'
equity and cash flows for the year then ended (not presented herein) and in our
report dated February 3, 1998, we expressed an unqualified opinion on those
consolidated financial statements.
New York, New York ERNST & YOUNG LLP
April 21, 1998
- 3 -
<PAGE>
NAC RE CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(In thousands)
<TABLE>
<CAPTION>
(Unaudited)
March 31, December 31,
1998 1997
------------- --------------
<S> <C> <C>
ASSETS
Investments:
Available for sale:
Fixed maturities (amortized cost: 1998, $2,031,210; 1997, $2,021,501) $2,099,022 $2,088,588
Equity securities (cost: 1998, $134,730; 1997, $124,999) 156,740 142,527
Short-term investments 86,744 108,489
------------- --------------
TOTAL INVESTMENTS 2,342,506 2,339,604
------------- --------------
Cash 8,438 8,430
Accrued investment income 33,547 36,347
Premiums receivable 229,839 227,569
Reinsurance recoverable balances, net 180,163 172,277
Reinsurance recoverable on unearned premiums 33,287 31,297
Deferred policy acquisition costs 93,550 92,709
Excess of cost over net assets acquired 3,184 3,276
Deferred tax asset, net 41,417 42,646
Other assets 43,453 30,710
------------- --------------
TOTAL ASSETS $3,009,384 $2,984,865
============= ==============
LIABILITIES
Claims and claims expenses $1,618,836 $1,603,972
Unearned premiums 306,693 301,711
8% Notes due 1999 100,000 100,000
7.15% Notes due 2005 99,943 99,942
5.25% Convertible Subordinated Debentures due 2002 100,000 100,000
Investment accounts payable 4,119 26,108
Revolving credit agreement 12,924 12,924
Other liabilities 83,724 83,147
------------- --------------
TOTAL LIABILITIES 2,326,239 2,327,804
============= ==============
STOCKHOLDERS' EQUITY
Preferred stock, $1.00 par value: 1,000 shares authorized, none issued
(Includes 90 shares of Series A Junior Participating Preferred Stock) - -
Common stock, $.10 par value:
25,000 shares authorized (1998, 21,783; 1997, 21,707 shares issued) 2,178 2,171
Additional paid-in capital 257,906 255,424
Accumulated other comprehensive income 65,281 60,989
Retained earnings 447,938 426,309
Less treasury stock, at cost (1998, 3,444; 1997, 3,398 shares) (90,158) (87,832)
------------- --------------
TOTAL STOCKHOLDERS' EQUITY 683,145 657,061
------------- --------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $3,009,384 $2,984,865
============= ==============
</TABLE>
See Notes to Consolidated Financial Statements
- 4 -
<PAGE>
NAC RE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INCOME
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
(Unaudited)
Three months ended March 31,
--------------------------------------
1998 1997
----------- -----------
<S> <C> <C>
PREMIUMS AND OTHER REVENUES
Net premiums written $136,190 $136,171
Increase in unearned premiums (2,836) (4,061)
----------- -----------
Premiums earned 133,354 132,110
Net investment income 32,085 28,572
Net investment gains 7,874 5,133
----------- -----------
Total revenues 173,313 165,815
OPERATING COSTS AND EXPENSES
Claims and claims expenses 88,692 87,531
Commissions and brokerage 33,443 32,886
Other operating expenses 17,126 15,177
Interest expense 5,426 5,474
----------- -----------
Total operating costs and expenses 144,687 141,068
INCOME
Income before income taxes 28,626 24,747
----------- -----------
Federal and foreign income taxes:
Current 6,684 10,857
Deferred (1,064) (5,964)
----------- -----------
Income tax expense (benefit) 5,620 4,893
----------- -----------
Net income $23,006 $19,854
=========== ===========
PER SHARE DATA
Basic:
Average shares outstanding 18,355 18,432
Operating income/net income $1.25 $1.08
Diluted (assuming conversion of dilutive convertible securities):
Average shares outstanding 20,954 20,712
Operating income/net income $1.14 $1.00
Cash dividends declared per share $0.075 $0.06
</TABLE>
See Notes to Consolidated Financial Statements
- 5 -
<PAGE>
NAC RE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(In thousands)
<TABLE>
<CAPTION>
(Unaudited)
---------------------------------------------------------------------------------------------
Accumulated
Other Total
Common Paid-in Comprehensive Retained Treasury Comprehensive Stockholders'
Stock Capital Income Earnings Stock Income Equity
----- ------- ------ -------- ----- ------ ------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, At December 31, 1997 $2,171 $255,424 $426,309 ($87,832) $60,989 $657,061
Comprehensive income:
Net income $23,006 23,006 23,006
Other comprehensive income,
net of tax:
Unrealized appreciation of
investments 3,384 3,384
Currency translation adjustments 908 908
Other comprehensive income 4,292 4,292
Total comprehensive income $27,298
Issuance of shares 7 2,482 2,489
Dividends declared on common stock (1,377) (1,377)
Purchase of treasury shares (2,326) (2,326)
-------- ------------ ------------ --------------- ---------- ------------ ----------------
Balance at March 31, 1998 $2,178 $257,906 $447,938 ($90,158) $65,281 $683,145
======== ============ ============ =============== ========== ============ ================
</TABLE>
<TABLE>
<CAPTION>
(Unaudited)
---------------------------------------------------------------------------------------------
Accumulated
Other Total
Common Paid-in Comprehensive Retained Treasury Comprehensive Stockholders'
Stock Capital Income Earnings Stock Income Equity
----- ------- ------ -------- ----- ------ ------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, At December 31, 1996 $2,146 $248,662 $335,868 ($73,484) $40,077 $553,269
Comprehensive income:
Net income $19,854 19,854 19,854
Other comprehensive income,
net of tax:
Unrealized depreciation of
investments (15,653) (15,653)
Currency translation adjustments (3,477) (3,477)
Other comprehensive income (19,130) (19,130)
Total comprehensive income $724
Issuance of shares 9 1,891 1,900
Dividends declared on common stock (1,109) (1,109)
Purchase of treasury shares (3,784) (3,784)
-------- ------------ ------------ --------------- ---------- ------------ ----------------
Balance at March 31, 1997 $2,155 $250,553 $354,613 ($77,268) $20,947 $551,000
======== ============ ============ =============== ========== ============ ================
</TABLE>
See Notes to Consolidated Financial Statements
- 6 -
<PAGE>
NAC RE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
(Unaudited)
Three months ended March 31,
------------------------------
1998 1997
------------- -------------
<S> <C> <C>
OPERATING ACTIVITIES
Net income $ 23,006 $ 19,854
Adjustments to reconcile net income to net cash
provided by operating activities:
Reserve for claims and claims expenses, net 4,929 241,349
Unearned premiums, net 2,819 4,058
Premiums receivable (1,991) (7,884)
Accrued investment income 2,848 (696)
Reinsurance balances, net 6,508 (44,290)
Deferred policy acquisition costs (805) (2,041)
Net investment gains (7,874) (5,133)
Deferred tax asset, net (1,082) (5,964)
Other liabilities (4,002) 11,745
Other items, net (10,455) (10,459)
------------- -------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 13,901 200,539
------------- -------------
INVESTING ACTIVITIES
Sales of fixed maturity investments 310,627 386,972
Maturities of fixed maturity investments 3,522 7,629
Purchases of fixed maturity investments (340,404) (467,650)
Net sales (purchases) of short-term investments 21,753 (110,841)
Sales of equity securities 7,951 22,236
Purchases of equity securities (14,296) (24,019)
Purchases of furniture and equipment (1,799) (1,040)
------------- -------------
NET CASH USED IN INVESTING ACTIVITIES (12,646) (186,713)
------------- -------------
FINANCING ACTIVITIES
Issuance of shares 2,309 1,671
Purchase of treasury shares, net of reissuance (2,326) (2,840)
Cash dividends paid to stockholders (1,372) (1,104)
------------- -------------
NET CASH USED IN FINANCING ACTIVITIES (1,389) (2,273)
------------- -------------
Effects of exchange rate changes on cash 142 129
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Increase in cash 8 11,682
Cash - beginning of year 8,430 18,853
------------- -------------
Cash - end of period $ 8,438 $ 30,535
============= =============
</TABLE>
See Notes to Consolidated Financial Statements
- 7 -
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. General
The accompanying consolidated financial statements have been prepared on
the basis of generally accepted accounting principles and in the opinion
of management, reflect all adjustments necessary (consisting of normal
recurring accruals) for a fair presentation of results for such periods.
These consolidated financial statements should be read in conjunction with
the consolidated financial statements and related notes contained in the
Company's Annual Report to Shareholders.
2. Per Share Data
Basic earnings per share is based on weighted average common shares and
excludes any dilutive effects of options and convertible securities.
Diluted earnings per share assumes the conversion of dilutive convertible
securities and the exercise of all dilutive stock options. All earnings
per share amounts for all periods have been presented, and where
appropriate, restated to conform to the Statement No. 128 requirements.
<TABLE>
<CAPTION>
(In Thousands)
Three Months Ended March 31,
----------------------------
1998 1997
------- -------
<S> <C> <C>
Basic Earnings Per Share:
Net income $23,006 $19,854
Weighted average shares 18,355 18,432
Basic earnings per share $ 1.25 $ 1.08
Diluted Earnings Per Share:
Net income $23,006 $19,854
Add back after-tax interest on convertible
debentures 876 876
------- -------
Adjusted net income $23,882 $20,730
======= =======
Weighted average shares 18,355 18,432
Assumed exercise of dilutive stock options (1) 579 260
Assumed conversion of convertible debentures (2) 2,020 2,020
------- -------
Weighted average shares and dilutive securities 20,954 20,712
======= =======
Diluted earnings per share $ 1.14 $ 1.00
======= =======
</TABLE>
(1) Computed utilizing the average market price of Common Stock for the
period.
(2) Reflects the assumed conversion of the Company's 5.25% Convertible
Subordinated Debentures due 2002.
<PAGE>
3. Retrocession
The Company's balance sheets as of March 31, 1998 and December 31, 1997
reflect reinsurance recoverable balances as assets, the components of
which are stated in the table below.
(In Thousands)
Reinsurance Recoverable Balances, Net
-------------------------------------
March 31, 1998 December 31, 1997
---------------- ----------------
Paid Claims $ 11,486 $ 10,646
Unpaid Claims and Claims Expenses 205,872 196,836
Ceded Balances Payable (36,265) (34,305)
Funds Held Liability (930) (900)
---------------- ----------------
Net $ 180,163 $ 172,277
================ ================
The effect of retrocessional activity on premiums written, premiums earned
and claims expenses is as follows:
(In Thousands)
Three months ended
March 31,
------------------------
1998 1997
------------------------
Ceded premiums written $29,178 $32,371
Ceded premiums earned $27,919 $29,926
Ceded claims and claims expenses $16,858 $18,763
4. Comprehensive Income
In the first quarter of 1998, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income,"
which requires that a company classify items that meet the definition of
components of other comprehensive income in a financial statement and
display the accumulated balance of other comprehensive income in the
equity section of the statement of financial position. Comprehensive
income includes all changes in equity during a period resulting from
transactions and other events from nonowner sources. Accumulated other
comprehensive income, net of tax, for the Company includes unrealized
appreciation of investments and foreign currency translation adjustments,
which totaled $65.3 million at March 31, 1998.
5. Subsequent Event
On April 30, 1998, the Company, along with Mellon Bank Corporation,
announced the signing of a letter of intent to each purchase a significant
interest in Prime Advisors, Inc. ("Prime"), a Washington-based investment
advisor firm. Prime is a market leader in the specialized
property/casualty insurance asset management industry. In addition to the
stock purchase, NAC Re intends to retain Prime to manage a segment of its
invested assets.
The transaction is subject to completion of a definitive agreement and
receipt of required regulatory approvals. The purchase is not expected to
have a material impact on the financial condition or results of operations
of the Company in 1998.
<PAGE>
Management's Discussion and Analysis of
Financial Condition and Results of Operations
NAC Re Corporation ("NAC Re") is the holding company for NAC Reinsurance
Corporation ("NAC") and its wholly owned insurance and reinsurance domestic and
foreign subsidiaries. NAC Re and its subsidiaries are collectively referred to
as the Company.
Results of Operations
Operating earnings, excluding investment gains, of $17.9 million or $.90 per
diluted share, increased 8.4% over the $.83 per diluted share that was reported
in the comparable quarter of 1997. Net income, including investment gains, was
$23.0 million or $1.14 per diluted share representing an increase of 14% over
the $1.00 per diluted share that was reported for the 1997 first quarter.
Realized investment gains, net of tax, were $5.1 million or $.24 per diluted
share for the 1998 first quarter, compared to $3.5 million or $.17 per diluted
share for the 1997 first quarter.
Premium Revenues
The Company's growth in premium revenue for its domestic and international
operations are as follows:
(In Millions)
Net Premiums Written
Three Months Ended March 31,
------------------------------------
1998 1997 % Chg
----------- ----------- ----------
Domestic:
Casualty $ 67.3 $ 75.7 (11.2)%
Property 34.4 27.3 25.9
Specialty/Other 19.6 19.3 2.0
----------- ----------- ----------
Subtotal 121.3 122.3 (0.8)
----------- ----------- ----------
International:
Casualty 6.7 7.1 (4.7)
Property 6.0 6.8 (12.5)
Specialty/Other 2.2 -- --
----------- ----------- ----------
Subtotal 14.9 13.9 7.3
----------- ----------- ----------
Total $ 136.2 $ 136.2 -- %
=========== =========== ==========
As shown in the table above, the Company's worldwide net premiums written for
the 1998 first quarter were $136.2 million, equal to the premiums reported in
the 1997 first quarter. Domestic net premiums written for the 1998 first quarter
were $121.3 million, compared to $122.3 million for the 1997 first quarter.
Domestic casualty net premiums written decreased 11.2% from the comparable 1997
period, primarily as a result of extremely competitive market conditions, the
availability of significant capital and the increased retention of primary
companies. Property net premiums written for the 1998 first quarter increased
25.9%. The increase is primarily attributable to growth in both our facultative
and treaty businesses, coupled with favorable ceded premium charges. Net
premiums written from the specialty lines which consist of fidelity/surety,
ocean marine, aviation business and certain primary program business totaled
$19.6 million, an increase of 2.0% over the 1997 first quarter.
The Company's international operation, NAC Reinsurance International Limited,
reported net premiums written of $14.9 million for the 1998 first quarter,
compared to $13.9 million for the 1997 first quarter. Net premium growth for the
first quarter includes the results of our new subsidiary, Stonebridge
Underwriting Ltd., which is participating at Lloyd's as a corporate capital
vehicle on the Denham Syndicate commencing with the 1998 underwriting year.
<PAGE>
In January 1998, the Company announced an agreement in principle to acquire the
managing agency assets of Morgan, Fentiman & Barber (MFB), a Lloyd's managing
agency. MFB currently manages Denham Syndicate 990 which underwrites a
specialized book of business, including both direct and reinsurance business.
This acquisition is expected to close later this year upon the completion of due
diligence and regulatory approval. However, there are no assurances that this
acquisition will be consummated. The transaction is not expected to have a
material impact on the financial condition or results of operations of the
Company in 1998.
Operating Costs and Expenses
Generally, claims and claims expenses represent the Company's most significant
and uncertain costs. These expenses are only estimates at a given point in time
of what the insurer or reinsurer expects the ultimate settlement and
administration of claims to cost based on facts and circumstances then known.
The Company would generally expect to refine such estimates in subsequent
accounting periods with adjustments possible in either direction as additional
information becomes known.
One traditional means of measuring the underwriting performance of a
property/casualty insurer is the statutory composite ratio. The composite ratio,
based upon statutory accounting practices which differ from generally accepted
accounting principles in several respects, reflects underwriting experience, but
does not reflect income from investments. A composite ratio under 100% indicates
underwriting profitability while a composite ratio exceeding 100% indicates an
underwriting loss.
The following chart sets forth statutory composite ratios and the relevant
components for the periods indicated for the Company's domestic reinsurance
subsidiary. The consolidated statutory composite ratio combines the results of
the Company's international subsidiary on a U.S. statutory basis:
<TABLE>
<CAPTION>
Three months ended Year ended
March 31, December 31,
------------------------ -----------
1998 1997 1997
---------- ---------- -----------
<S> <C> <C> <C>
Claims and Claims Expenses 66.0 % 65.8 % 65.9 %
Commissions and Brokerage 25.8 26.1 27.3
Other Underwriting Expenses 11.0 10.2 9.9
---------- ---------- -----------
Domestic Statutory Composite Ratio 102.8 % 102.1 % 103.1 %
---------- ---------- -----------
International Statutory Composite Ratio 108.9 % 109.4 % 108.9 %
---------- ---------- -----------
Consolidated Statutory Composite Ratio 103.5 % 102.8 % 103.6 %
---------- ---------- -----------
</TABLE>
The Company's domestic statutory composite ratio for the 1998 first quarter was
102.8% compared with 102.1% for the 1997 first quarter ratio. The slight
increase in the composite ratio compared to the prior year is reflective of the
impact of the competitive market conditions on pricing adequacy coupled with an
increase in underwriting expenses.
The Company experienced net favorable claim development for business written
since 1986. This favorable development is driven by several factors, some of
which are interdependent. A principal factor is the strength of the actuarial
assumptions underlying the business written, particularly with respect to social
and economic inflation. These actuarial assumptions are utilized to establish
the initial expected target loss ratio employed in the actuarial methodologies
from which the reserves for claims and claims expenses are derived. Such loss
ratios are periodically adjusted to reflect comparisons of actuarially-computed
expected claims to actual claims and claims expense development, inflation and
other considerations. The favorable development in more recent underwriting
years has offset certain unfavorable development on business written prior to
1986, including asbestos and environmental claims.
The pricing of the Company's reinsurance contracts contemplates many factors,
including exposure to claims and the expenses of both the client company and
broker. The Company's actuaries and underwriters evaluate the adequacy of
premium revenue net of these expenses, thereby mitigating the effect of
variations in these expenses to overall underwriting results. The Company's
commission and brokerage ratio for the 1998 first quarter reflects a decrease
compared to the 1997 first quarter, principally due to the effects of certain
contractual provisions which adjust commission expense based on claim
experience.
<PAGE>
Other underwriting expenses for the 1998 first quarter have increased as
compared to the 1997 prior year period, reflecting continued business expansion,
investments in technology and the continued investment in our facultative
infrastructure.
Investments
Cash and invested assets at both March 31, 1998 and December 31, 1997 were $2.3
billion, excluding net investment payables of $4.1 million and $25.8 million for
1998 and 1997, respectively.
Net investment income for the 1998 first quarter was $32.1 million, an increase
of 12.3% over the 1997 comparable period. On an after-tax basis, net investment
income for the 1998 first quarter was $25.6 million or $1.22 per diluted share,
an increase of 13.7% over the comparable 1997 period. The increase is primarily
attributable to the higher invested asset base coupled with the increase in the
Company's investment in tax-exempt securities. The Company's pretax investment
yield was 5.7% for the 1998 first quarter, compared to 5.6% for the 1997 first
quarter. The after-tax investment yield for the 1998 first quarter was 4.5%,
compared to 4.4% for the comparable prior year period.
Net investment gains, net of tax for the 1998 first quarter were $5.1 million or
$.24 per diluted share, compared to net investment gains of $3.5 million or $.17
per diluted share for the 1997 first quarter. Gains and losses on the sale of
investments are recognized as a component of operating income, but the timing
and recognition of such gains and losses are unpredictable and are not
indicative of future operating results.
The Company's investment strategy is focused principally on income
predictability and asset value stability. The Company's emphasis on high quality
fixed maturity investments reflects this strategy. Tactical shifts between
taxable and tax-exempt bonds may occur in order to maximize after-tax investment
returns without compromising balance sheet integrity. At March 31, 1998, our
fixed maturity investments amounted to $2.1 billion, which approximates 89% of
cash and invested assets, and approximately 94% of such investments are rated
investment grade by Moody's Investor Services, Inc. or Standard & Poor's.
The balance of the Company's investment portfolio at March 31, 1998, consisting
of cash, short-term investments and equity securities, amounted to $251.9
million. As of March 31, 1998, the Company held approximately $156.7 million or
6.7% of cash and invested assets in equity securities which represented 22% of
statutory surplus.
Uncertainties exist regarding interest rates and inflation and their potential
impact on the market values of the Company's fixed income securities. The
Company actively considers the risks and financial rewards associated with the
maturity distribution of its fixed income portfolio. In this regard, the Company
takes into consideration the pattern of expected claim payments and the
Company's future cash flow projections in evaluating its investment
opportunities. As of March 31, 1998, the Company's fixed maturity investment
securities had an average duration of 5.5 years.
Liquidity and Capital Resources
NAC Re is a holding company and has no revenue producing operations of its own.
Cash flow within NAC Re consists of investment income, operating and interest
expenses, dividends to stockholders, rental income, and dividends and tax
reimbursements from NAC. These dividends from NAC are subject to statutory
restrictions.
The statutory surplus of the reinsurance subsidiary, NAC Reinsurance Corporation
was $716.7 million at March 31, 1998 which ranks among the largest domestic
reinsurers measured on this basis.
Total assets exceeded $3.0 billion at March 31, 1998. Stockholders' equity
reached $683.1 million or $37.25 per share at March 31, 1998 compared to $657.1
million or $35.89 per share at December 31, 1997. The unrealized appreciation of
investments, net of tax, which is the principal component of accumulated other
comprehensive income, increased to $58.4 million at March 31, 1998 from $55.0
million at December 31, 1997.
<PAGE>
Cash flow from operations for the 1998 first quarter was $13.9 million compared
to $200.5 million for the comparable 1997 period. The 1997 cash flow from
operations included approximately $180 million from the termination of two
retrocessional programs. Excluding the impact of the termination, the decline in
cash flow from the prior year period is attributed to higher claim and other
underwriting expense payments.
NAC Re maintains a revolving credit facility under which it can borrow up to $35
million. Outstanding borrowings as of March 31, 1998 were $12.9 million and were
principally used to finance the Company's periodic repurchase of Common Stock.
The facility is scheduled to be reduced on a quarterly basis beginning in July
1998.
NAC maintains a $15 million line of credit facility which is available for
catastrophe claim payments or working capital purposes. There have been no
borrowings under this facility.
During the first three months of 1998, the Company repurchased approximately
46,000 shares of common stock at an average cost of $51.01 per share.
Subsequently, the Company has repurchased an additional 154,000 shares. From the
inception of the program, approximately 3.6 million shares have been repurchased
at an average cost of $27.14 per share. Approximately 456,000 shares remain
authorized for repurchase under the program.
The Company declared a quarterly cash dividend of $.075 per share for the 1998
first quarter. The regular cash dividend was increased to $.075 from $.06 per
share in June 1997.
Impact of the Year 2000 Issue
The Company began assessing the impact of the Year 2000 issue on its computer
hardware and software systems in 1995. Certain systems have been identified for
replacement before year-end 1999 due to normal business requirements. The
replacement systems will be reviewed or designed to ensure they are Year 2000
compliant prior to implementation. Systems not identified for replacement are
expected to be assessed and made Year 2000 compliant prior to year end 1999 at a
cost that is not expected to be material to the Company. Currently management is
conducting a review of all such systems. As of March 31, 1998, management had
not identified any hardware or software computer system with a significant Year
2000 compliance problem that would be expected to have a materially adverse
affect on the Company's financial condition or results of operations.
The Company is currently contacting certain customers, retrocessionnaires,
reinsurance intermediaries, managing general agents, suppliers, and other
constituents to determine the nature and extent of their Year 2000 compliance
efforts and to assess whether their noncompliance would have a material adverse
affect on the Company's financial condition or results of operations.
There is presently uncertainty as to whether Year 2000-related claims will have
a material affect on the industry's financial condition or results of
operations. Due to these uncertainties, the Company believes that no meaningful
range of claims and claims expense liabilities beyond recorded reserves can be
established. As these uncertainties are resolved, additional reserve provisions,
which could be material in amount, may be necessary.
Regulatory Initiatives
NAC Re and its domestic subsidiaries are subject to regulatory oversight under
the insurance statutes and regulations of the jurisdictions in which they
conduct business, including all states of the United States and Canada. NAC Re's
international subsidiary is subject to the regulatory authority of the United
Kingdom Department of Trade and Industry. The international subsidiary's
Australian branch office is also subject to the Australian Insurance and
Supervisory Commission's solvency and regulatory authority. These regulations
vary from jurisdiction to jurisdiction, and are generally designed to protect
ceding insurance companies and policyholders by regulating the Company's
financial integrity and solvency in its business transactions and operations.
Many of the insurance statutes and regulations applicable to the Company relate
to reporting and disclosure standards which allow insurance regulators to
closely monitor the Company's performance. Typical required reports include
information concerning the Company's capital structure, ownership, financial
strength and general business operations.
<PAGE>
In 1993, the National Association of Insurance Commissioners (the "NAIC"), by
adopting a model risk-based capital act, intended to provide an additional tool
for regulators to evaluate the capital of property and casualty insurers and
reinsurers with respect to the risks assumed by them and determine whether there
is a perceived need for corrective action. The nature of the corrective action
depends upon the extent of the calculated risk-based capital deficiency and
ranges from requiring the Company to submit a comprehensive plan to placing the
insurer under regulatory control. While the model risk-based capital act has not
yet been adopted in New York, NAC's domicile, New York has issued a circular
letter requiring the filing of risk-based capital reports by property and
casualty insurers and reinsurers. The NAIC also adopted a proposal that requires
property and casualty insurers and reinsurers to report the results of their
risk-based capital calculations as part of the statutory annual statements filed
with state regulatory authorities. Surplus (as calculated for statutory annual
statement purposes) for each of the Company's domestic subsidiaries is well
above the risk-based capital thresholds that would require either company or
regulatory action.
Various other regulatory and legislative initiatives have been proposed from
time to time that could impact reinsurers. Generally, the thrust of regulatory
efforts has been to improve the solvency of reinsurers and create incentives for
insurers to do business with well capitalized, prompt paying reinsurers
operating under U.S. jurisdiction. While we cannot quantify the impact of these
regulatory efforts on the Company's operations, we believe the Company is
adequately positioned to compete in an environment of more stringent regulation.
Safe Harbor Disclosure for Forward-Looking Statements
In connection with the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995 (the "Act"), the Company sets forth below
cautionary statements identifying important factors that could cause the
Company's actual results to differ materially from those which might be
projected, forecasted, or estimated or otherwise implied in the Company's
forward-looking statements, as defined in the Act, made by or on behalf of the
Company in press releases, written statements or documents filed with the
Securities and Exchange Commission, or in its communications and discussions
with investors and analysts in the normal course of business through meetings,
telephone calls and conference calls. Such statements may include, but are not
limited to, projections of premium revenue, investment income, other revenue,
losses, expenses, earnings (including earnings per share), cash flows, plans for
future operations, common shareholders' equity, financing needs, capital plans,
dividends, plans relating to products or services of the Company, and estimates
concerning the effects of litigation or other disputes, as well as assumptions
for any of the foregoing and are generally expressed with words such as
"believes," "estimates," "expects," "anticipates," "could have," "may have," and
similar expressions.
Forward-looking statements are inherently subject to risks and uncertainties.
The Company cautions that factors which may cause the Company's results to
differ materially from such forward-looking statements include, but are not
limited to, the following:
Changes in the level of competition in the reinsurance or primary
insurance markets that adversely affect the volume or profitability of the
Company's business. These changes include, but are not limited to, the
intensification of price competition, the entry of new competitors,
existing competitors exiting the market, and the development of new
products by new and existing competitors;
Changes in the demand for reinsurance, including changes in ceding
companies' retentions, and changes in the demand for primary and excess
and surplus lines insurance coverages;
The ability of the Company to execute its business strategies;
Changes in the frequency and severity of catastrophes which could
significantly impact the Company's business in terms of net income,
reinsurance costs, and cash flow;
<PAGE>
Adverse development on claims and claims expense liabilities related to
business written in prior years, including, but not limited to, evolving
case law and its effect on environmental and other latent injury claims,
changing government regulations, newly identified toxins, newly reported
claims, inflation, new theories of liability, or new insurance and
reinsurance contract interpretations;
Changes in the Company's retrocessional arrangements;
Lower than estimated retrocessional or reinsurance recoveries on unpaid
losses, including, but not limited to, losses due to a decline in the
creditworthiness of the Company's retrocessionnaires or reinsurers;
Increases in interest rates, which cause a reduction in the market value
of the Company's interest rate sensitive investments, including, but not
limited to, its fixed income investment portfolio, and its common
shareholders' equity and decreases in interest rates causing a reduction
of income earned on new cash flow from operations and the reinvestment of
the proceeds from sales, calls or maturities of existing investments;
Declines in the value of the Company's common equity investments and
credit losses on the Company's investment portfolio;
Gains or losses related to foreign currency exchange rate fluctuations;
and
Adverse results in litigation matters including, but not limited to,
litigation related to environmental, asbestos, other potential mass tort
claims, and claims related to the Year 2000.
In addition to the factors outlined above that are directly related to the
Company's business, the Company is also subject to general business risks,
including, but not limited to, adverse state, federal or foreign legislation and
regulation, adverse publicity or news coverage, changes in general economic
factors, and the loss of key employees.
<PAGE>
PART II. OTHER INFORMATION
Item 6. Exhibits
(a) Exhibit Index:
Exhibit Description Page
15 Letter Re: Unaudited Interim Financial Information 18
27 Financial Data Schedule 19
(b) There were no reports filed on Form 8-K for the three months ended March
31, 1998.
Omitted from this Part II are items which are inapplicable or to which the
answer is negative for the period covered.
<PAGE>
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NAC Re CORP.
(Registrant)
Date: May 8, 1998 NICHOLAS M. BROWN, JR.
---------------------------- --------------------------------------
Nicholas M. Brown, Jr.
President and Chief Operating Officer
Date: May 8, 1998 JEROME T. FADDEN
---------------------------- --------------------------------------
Jerome T. Fadden
Vice President, Chief Financial Officer
and Treasurer
EXHIBIT 15
Acknowledgment Letter
To the Stockholders and Board of Directors
NAC Re Corporation
We are aware of the incorporation by reference in the Registration Statements
(Form S-8 No. 33-25585, Form S-8 No. 33-77494 and Form S-8 No. 333-33873)
pertaining to the NAC Re Corp. Employee Stock Purchase Plan, in the Registration
Statement (Form S-8 No. 33-27745) pertaining to the NAC Re Corp. 1989 Stock
Option Plan, in the Registration Statement (Form S-8 No. 33-7813) pertaining to
the NAC Re Corp. 1985 and 1986 Stock Option Plans, in the Registration
Statements (Form S-8 No. 33-22841 and Form S-8 No. 333-03935) pertaining to the
NAC Re Corp. Employee Savings Plan, in the Registration Statement (Form S-8 No.
33-34516) pertaining to the NAC Re Corp. Director's Stock Option Plan, in the
Registration Statement (Form S-8 No. 33-77492) pertaining to the NAC Re Corp.
Director's Stock Option Plan, and in the Registration Statement (Form S-8 No.
33-77114) pertaining to the NAC Re Corp. 1993 Stock Option Plan, in the
Registration Statement (Form S-8 No. 333-33875) pertaining to the NAC Re Corp.
1997 Incentive and Capital Accumulation Plan, of our report dated April 21,
1998, relating to the unaudited consolidated interim financial statements of NAC
Re Corporation that is included in its Form 10-Q for the quarter ended March 31,
1998.
ERNST & YOUNG LLP
New York, New York
April 21, 1998
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