SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------------
FORM 10-Q
----------------------
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED JUNE 30, 1999
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES AND EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____TO____
------------------------------------------------------
CAPITAL RE CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
------------------------------------------------------
DELAWARE 1-10995 52-1567009
(STATE OR OTHER JURISDICTION (COMMISSION FILE NUMBER) (IRS EMPLOYER
OF INCORPORATION OR IDENTIFICATION
ORGANIZATION) NUMBER)
1325 AVENUE OF THE AMERICAS
18TH FLOOR
NEW YORK, NEW YORK 10019
(212) 974-0100
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED
TO BE FILED BY SECTIONS 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 (REGISTRANT BECAME SUBJECT TO THE
FILING REQUIREMENTS ON APRIL 8, 1992.)
AS OF AUGUST 13, 1999 THERE WERE 36,523,398 OUTSTANDING SHARES OF COMMON STOCK,
PAR VALUE $.01 PER SHARE, OF THE REGISTRANT
<PAGE>
CAPITAL RE CORPORATION AND SUBSIDIARIES
INDEX
PART I FINANCIAL INFORMATION PAGE
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED) CAPITAL RE CORPORATION
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS -JUNE 30, 1999 (UNAUDITED) AND
DECEMBER 31, 1998 3
CONSOLIDATED STATEMENTS OF INCOME - THREE AND SIX MONTHS 4
ENDED JUNE 30, 1999 (UNAUDITED) AND JUNE 30, 1998
(UNAUDITED)
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME - THREE AND SIX 5
MONTHS ENDED JUNE 30, 1999 (UNAUDITED) AND JUNE 30, 1998
(UNAUDITED)
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY - SIX MONTHS
ENDED JUNE 30, 1999 (UNAUDITED) 6
CONSOLIDATED STATEMENTS OF CASH FLOWS - SIX MONTHS ENDED
JUNE 30, 1999 (UNAUDITED) AND JUNE 30, 1998 (UNAUDITED) 7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 8-14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 15-32
PART II OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 33
ITEM 5. OTHER INFORMATION 34
INFORMATION REGARDING SHAREHOLDER PROPOSALS AT THE 2000
ANNUAL MEETING
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 36-45
SIGNATURES 35
<PAGE>
CAPITAL RE CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
(Dollars in thousands except per share amounts)
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
(Unaudited)
----------- ------------
<S> <C> <C>
Assets
Fixed maturity securities available for sale, at market
(amortized cost: $1,096,903 in 1999 and $1,036,862 in 1998) $ 1,093,252 $ 1,086,891
Short-term investments, at cost, which approximates market 141,796 88,147
----------- -----------
Total Investments 1,235,048 1,175,038
Cash 14,082 9,893
Accrued investment income 15,167 15,371
Deferred acquisition costs 149,561 135,029
Prepaid reinsurance premiums 45,328 49,603
Reinsurance recoverable on ceded losses 3,468 3,292
Funds held under reinsurance agreements 6,105 5,033
Premiums receivable, net 15,806 16,997
Amounts receivable on ceded annuity reserves 0 53,869
Investment in affiliates 17,930 15,080
Net assets of discontinued operations 0 11,695
Other assets 28,153 17,873
----------- -----------
Total Assets $ 1,530,648 $ 1,508,773
=========== ===========
Liabilities
Deferred premium revenue $ 425,238 $ 405,866
Reserve for losses and loss adjustment expenses 142,601 87,960
Annuity benefit reserves 49,104 53,869
Accident and health reserves 41,730 17,843
Profit commission liability 63,874 57,389
Deferred federal income taxes payable 38,129 79,237
Bank note payable 25,000 25,000
Long-term debt 74,875 74,856
Net liabilities of discontinued operations 11,958 0
Other liabilities 28,371 20,927
----------- -----------
Total Liabilities $ 900,880 $ 822,947
----------- -----------
Company Obligated Mandatorily Redeemable
Preferred Securities of Capital Re LLC 75,000 75,000
Stockholders' Equity
Preferred stock - $.01 par value per share; 25,000,000 shares
authorized; no shares issued and outstanding
in 1999 and 1998 -- --
Common stock - $.01 par value per share; 75,000,000 shares
authorized, 36,523,398 and 31,929,119 shares issued and
outstanding in 1999 and 1998, respectively 369 324
Additional paid-in capital 302,539 227,280
Retained earnings 259,071 355,693
Treasury stock; 428,000 and 428,000 shares in 1999 and 1998, respectively (4,891) (4,891)
Other Comprehensive Income
Net unrealized (loss)/gain on fixed maturities securities available
for sale, net of reclassification adjustment (2,220) 32,520
Net unrealized loss on foreign exchange translation (100) (100)
----------- -----------
Accumulated Other Comprehensive Income (2,320) 32,420
----------- -----------
Total Stockholders' Equity 554,768 610,826
----------- -----------
Total Liabilities, Preferred Securities of Capital Re LLC and
Stockholders' Equity $ 1,530,648 $ 1,508,773
=========== ===========
</TABLE>
See Accompanying Notes to Unaudited Consolidated Financial Statements
3
<PAGE>
CAPITAL RE CORPORATION AND SUBSIDIARIES
Consolidated Statements of Income
(Dollars in thousands except per share amounts)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
(Unaudited) (Unaudited)
-------------------------------- --------------------------------
1999 1998 1999 1998
-------------------------------- --------------------------------
<S> <C> <C> <C> <C>
Revenues:
Orgination premiums written $60,583 $55,804 $119,039 $117,932
Canceled Reinsurance 0 0 9,567 0
-------------------------------- --------------------------------
Gross premiums written $60,583 $55,804 $109,472 $117,932
Ceded premiums 1,135 440 3,198 1,521
-------------------------------- --------------------------------
Net premiums written 59,448 55,364 106,274 116,411
Increase in deferred premium revenue (19,409) (16,139) (23,647) (33,455)
-------------------------------- --------------------------------
Net premiums earned 40,039 39,225 82,627 82,956
Net investment income 17,685 16,187 34,849 32,052
Net realized gain 4,621 1,281 5,028 2,461
Fee income 664 437 759 617
Other income 11 23 21 187
Equity income in affiliate 904 101 2,394 133
-------------------------------- --------------------------------
Total Revenues 63,924 57,254 125,678 118,406
-------------------------------- --------------------------------
Expenses:
Loss and loss adjustment expenses 175,134 2,606 187,927 12,592
Acquisition costs 14,330 15,747 41,597 34,618
Decrease/(increase) in deferred acquisition costs 406 (3,896) (14,533) (9,248)
Profit commission expense 3,470 7,716 7,228 10,588
Other operating expenses 4,691 3,882 7,989 7,855
Interest expense 1,902 1,851 3,747 3,730
Foreign exchange loss 235 376 724 36
Minority interest in Capital Re LLC 1,434 1,434 2,869 2,869
-------------------------------- --------------------------------
Total Expenses 201,602 29,716 237,548 63,040
-------------------------------- --------------------------------
(Loss)/income before provision for federal income taxes (137,678) 27,538 (111,870) 55,366
(Benefit from)/provision for federal income taxes
Current (18,967) 7,229 (18,059) 11,321
Deferred (29,119) 626 (23,597) 4,087
-------------------------------- --------------------------------
Total (benefit from)/provision for federal income taxes (48,086) 7,855 (41,656) 15,408
-------------------------------- --------------------------------
Net (loss)/income from continuing operations ($89,592) $19,683 ($70,214) $39,958
Discontinued operations:
Income from operations 0 503 0 23
Loss on disposal (17,222) 0 (23,665) 0
-------------------------------- --------------------------------
(Loss)/income from discontinued operations, net of tax (17,222) 503 (23,665) 23
Net (Loss)/Income ($106,814) $20,186 ($93,879) $39,981
================================ ================================
Net (Loss)/Income from Continuing Operations
Per Common Share:
Basic ($2.73) $0.62 ($2.17) $1.25
Diluted ($2.70) $0.60 ($2.14) $1.21
Net (Loss)/Income Per Common Share:
Basic ($3.26) $0.63 ($2.90) $1.26
Diluted ($3.22) $0.61 ($2.87) $1.21
Weighted Average Number of Shares Outstanding
Basic 32,795 31,865 32,404 31,849
Diluted 33,150 33,025 32,748 32,951
Cash dividends per common share $0.04 $0.04 $0.08 $0.08
</TABLE>
See Accompanying Notes to Unaudited Consolidated Financial Statements
4
<PAGE>
CAPITAL RE CORPORATION AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
(Dollars in thousands)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
(Unaudited) (Unaudited)
-------------------------- -------------------------
1999 1998 1999 1998
-------------------------- -------------------------
<S> <C> <C> <C> <C>
Net (Loss)/Income ($106,814) $20,186 ($93,879) $39,981
Other Comprehensive Income, net of tax:
Unrealized holding losses arising during period (21,462) 3,452 (29,712) 2,041
Reclassification adjustment for (losses)/gains included in net income (4,621) (1,281) (5,028) (2,461)
-------------------------- -------------------------
Change in net unrealized gain on fixed maturities securities
available for sale (26,083) 2,171 (34,740) (420)
Change in foreign exchange translation 56 (161) 0 23
-------------------------- -------------------------
Other Comprehensive (Loss)/Income (26,027) 2,010 (34,740) (397)
-------------------------- -------------------------
Comprehensive (Loss)/Income ($132,841) $22,196 ($128,619) $39,584
========================== =========================
</TABLE>
See Accompanying Notes to Unaudited Consolidated Financial Statements
5
<PAGE>
CAPITAL RE CORPORATION AND SUBSIDIARIES
Consolidated Statement of Stockholders' Equity
(Dollars in thousands except share amounts)
(Unaudited)
<TABLE>
<CAPTION>
Accumulated
Additional Other Total
Common Paid-In Retained Treasury Comprehensive Stockholders'
Stock Capital Earnings Stock Income Equity
----------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1999 $ 324 $ 227,280 $ 355,693 ($ 4,891) $ 32,420 $ 610,826
Net Income -- -- (93,879) -- -- (93,879)
Exercise of stock options, including tax benefit
(169,500 shares) 1 2,178 -- -- -- 2,179
Fixed maturities securities available for sale adjustments -- -- -- -- (34,740) (34,740)
Issuance of common stock (4,424,779 shares) (additional paid
in capital is net of capital issuance costs of $1,875) 44 73081 -- -- -- 73,125
Dividend ($.08 per common share) -- -- (2,743) -- -- (2,743)
----------------------------------------------------------------------
Balance, June 30, 1999 $ 369 $ 302,539 $ 259,071 ($ 4,891) ($ 2,320) $ 554,768
======================================================================
</TABLE>
See Accompanying Notes to Unaudited Consolidated Financial Statements.
6
<PAGE>
CAPITAL RE CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Dollars in thousands)
<TABLE>
<CAPTION>
Three Months Ended
June 30,
(Unaudited)
----------------------
1999 1998
----------------------
<S> <C> <C>
Operating Activities:
Net income ($ 93,879) $ 39,981
Adjustments to reconcile net income to
net cash provided by operating activities:
Amortization of bond discount on long-term debt 19 19
Net amortization of security premiums (815) (614)
(Benefit from)/provision for deferred federal income taxes (23,597) 4,017
Acquisition costs deferred 41,597 (34,618)
Amortization of deferred acquisition costs (56,130) 25,370
Equity Income in affiliates (2,394) (133)
Change in accrued investment income 204 (1,309)
Change in premiums receivable, net 698 (12,491)
Change in deferred premium revenue, net 23,647 33,455
Change in outstanding loss reserves, net 127,456 1,840
Net realized gain on investments (5,028) (2,461)
Change in ceded balances payable 493 699
Other 3,662 12,555
--------- ---------
Net Cash Provided by Operating Activities 15,934 66,310
Investing Activities:
Securities available-for-sale:
Purchases - fixed maturities (715,826) (398,667)
Sales-fixed maturites 663,049 316,811
Maturities (purchases) of short-term
investments, net (53,641) 10,328
Discontinued Operations, net 23,653 2,000
Other investing activities (1,540) (335)
--------- ---------
Net Cash Used in Investing Activities (84,305) (69,863)
Financing Activities:
Net proceeds from exercise of stock options 2,178 506
Net proceeds from issuance of stock 73,125 0
Dividends paid (2,743) (2,548)
--------- ---------
Net Cash Used by Financing Activities 72,560 (2,042)
(Decrease) Increase in Cash 4,189 (5,595)
Cash at Beginning of Period 9,893 14,103
--------- ---------
Cash at End of Period $ 14,082 $ 8,508
========= =========
</TABLE>
See Accompanying Notes to Unaudited Consolidated Financial Statements.
7
<PAGE>
CAPITAL RE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
June 30, 1999
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements and footnotes have
been prepared in accordance with the instructions to Form 10-Q and the
preparation of unaudited interim financial statements under the Rules and
Regulations of the Securities and Exchange Commission and do not include all the
information and disclosures required by generally accepted accounting
principles. These statements should be read in conjunction with the audited
consolidated financial statements of Capital Re Corporation and Subsidiaries
(the "Corporation") included in the Corporation's 1998 Annual Report on Form
10-K. The accompanying unaudited consolidated financial statements include all
adjustments, consisting only of normal recurring adjustments, necessary to
present fairly the Corporation's financial position and results of operations.
The results of operations for the six months ended June 30, 1999 may not be
indicative of the results that may be expected for the year ending December 31,
1999.
As of January 1, 1998, the Corporation adopted Statement of Financial Accounting
Standard 130, "Reporting Comprehensive Income" ("FAS 130"). Statement 130
establishes new rules for the reporting and display of comprehensive income and
its components; however, the adoption of this Statement had no impact on the
Corporation income or shareholders' equity. FAS 130 requires unrealized gains or
losses on the Corporation's available-for-sale securities and foreign currency
translation adjustments, which prior to adoption were reported separately in
shareholders' equity to be included in other comprehensive income. Prior year
financial statements have been reclassified to conform to the requirements of
Statement 130. For the three months and six months ended June 30, 1999 and 1998,
total comprehensive (loss)/income amounted to ($132.8) million and ($128.6)
million, and $22.2 million and $39.6 million, respectively.
Beginning in the third quarter of 1998, the Corporation's investment in Lloyd's
which was previously consolidated, is reflected as a discontinued operation
based on the Corporation's intention to pursue its divestiture. All prior period
results have been restated for comparative purposes.
8
<PAGE>
2. REINSURANCE
Ceded earned premium for both the three months and six months ended June 30,
1999 and 1998 were $3.7 million and $7.5 million, and $3.6 million and $7.4
million, respectively. Ceded losses for both the three months and six months
ended June 30, 1999 were ($50.4) million, and for the three months and six
months ended June 30, 1998 were $0.6 million and $1.1 million, respectively.
3. INCOME TAXES
The effective tax rate for the six months ended June 30, 1999 and 1998 is lower
than the federal corporate tax rate on ordinary income of 35% due principally to
the effect of tax-exempt interest income. No income taxes were paid as of June
30, 1999 and $9.1 million of income taxes were paid as of June 30, 1998.
4. SEGMENT REPORTING
The Corporation provides reinsurance to primary insurers in various specialty
insurance markets. For segment reporting purposes, the Corporation's reinsurance
lines of business are organized into four discrete segments - municipal
financial guaranty, nonmunicipal financial guaranty, each of which include
credit default swap transactions, mortgage guaranty and trade credit. Two
additional lines, financial solutions and title reinsurance are combined into
"Other" for segment reporting purposes. Operating procedures and corporate
resources are tailored to the business and regulatory needs of each line of
business or segment as necessary. In cases where practical, the same procedures
and or resources may be utilized for more than one line of business.
Financial guaranty insurance of municipal and nonmunicipal debt obligations, is
a form of credit enhancement which, as a specialized class of surety, provides
for the unconditional and irrevocable guarantee of the obligor's scheduled
payment of principal and interest on investment grade municipal and
non-municipal debt obligations. The premiums related to municipal bond
reinsurance are generally paid in full at the time of policy issuance, credited
to a deferred premium account and then recognized as revenues over the life of
the reinsured obligation. As a result, only a small portion of annual premium
revenue is derived from premiums written in any one year. Given the zero
expected loss underwriting standard, this multi-year revenue translates into an
annuity of earned premiums, which is itself supplemented by the investment
income derived from the deferred premiums account. Non-municipal financial
guaranty premiums are generally paid in installments over the life of the
underlying obligation, also providing an annuity of earned premiums.
9
<PAGE>
Mortgage guaranty insurance is a specialized class of credit insurance,
providing protection to mortgage lenders against default by borrowers on low
down-payment residential mortgage loans. For the Corporation's proportional
mortgage guaranty business, reinsurance premiums are paid on a monthly basis and
fully recognized when written. A certain level of losses is expected in this
business. For the non-proportional mortgage guaranty business, premiums are
generally paid in full at contract inception and earned over the life, usually
ten years. Generally, losses are not expected in this non-proportional mortgage
guaranty business. Credit insurance protects suppliers of goods and services
from the risk of non-payment by their customers. Some level of losses are also
expected in this business. This business is centered on blending participation
in excess of loss reinsurance programs with traditional proportional treaty
lines. These contracts are generally of a one year duration and premiums are
typically received in installments throughout the coverage period.
For purposes of financial planning, resource allocation and performance
evaluation, segments are measured based on net underwriting profits and other
income directly attributable to the segments. For segment reporting purposes,
investment income, net realized gains/losses, operating expenses (i.e.,
salaries, rent, etc.), interest expense and income taxes are allocated to the
segments. The mortgage segment includes equity income from an investment in a
subsidiary engaged in mortgage related products. Management does not allocate
assets to the Corporation's segments. Rather, assets are managed as a
consolidated pool.
For marketing purposes, the Corporation aggregates its reinsurance lines of
business into two divisions, Financial Guaranty and Financial Risks. The
municipal and non-municipal lines including credit default swaps, are combined
to represent Financial Guaranty while the Financial Risks division includes
mortgage, credit, title and financial solutions.
The following tables summarize the operating results of the Corporation's
segments:
<TABLE>
<CAPTION>
Three Months Ended June 30, 1999
Reportable Segments
-------------------------------------------------------------------------
Municipal Non Mortgage Credit Other Consolidated
Municipal
-------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Origination Written Premiums $ 13,205 $ 10,084 $ 24,513 $ 8,135 $ 4,647 $ 60,584
Canceled Reinsurance 0 0 0 0 0 0
-------------------------------------------------------------------------
Gross Written Premiums 13,205 10,084 24,513 8,135 4,647 60,584
Net Premiums Written 12,250 10,023 24,513 8,034 4,630 59,450
Net Premiums Earned 5,770 8,090 12,851 8,489 4,838 40,038
Net Underwriting (Loss)/Profit and
Other
Segment Related (Loss)/Income ($11,190) ($55,756) $ 635 ($ 2,627) ($82,549) ($151,487)
</TABLE>
10
<PAGE>
<TABLE>
<CAPTION>
Six Months Ended June 30, 1999
Reportable Segments
-------------------------------------------------------------------------
Municipal Non Mortgage Credit Other Consolidated
Municipal
-------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Origination Written Premiums $ 33,637 $ 22,353 $ 36,641 $ 17,195 $ 9,213 $119,039
Canceled Reinsurance 0 9,567 0 0 0 9,567
-------------------------------------------------------------------------
Gross Written Premiums 33,637 12,786 36,641 17,195 9,213 109,472
Net Premiums Written 31,661 11,792 36,641 16,984 9,196 106,274
Net Premiums Earned 15,377 14,706 25,637 17,537 9,369 82,626
Net Underwriting (Loss)/Profit and
Other
Segment Related (Loss)/Income ($ 6,711) ($51,532) $ 5,515 ($ 1,330) ($81,158) ($135,216)
</TABLE>
<TABLE>
<CAPTION>
Three Months Ended June 30, 1998
Reportable Segments
-------------------------------------------------------------------------
Municipal Non Mortgage Credit Other Consolidated
Municipal
-------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Origination Written Premiums $ 16,475 $ 6,192 $ 21,041 $ 9,829 $ 2,268 $ 55,805
Canceled Reinsurance 0 0 0 0 0 0
-------------------------------------------------------------------------
Gross Written Premiums 16,475 6,192 21,041 9,829 2,268 55,805
Net Premiums Written 16,087 6,192 21,041 9,777 2,268 55,365
Net Premiums Earned 9,828 4,842 14,680 7,429 2,447 39,226
Net Underwriting Profit and Other
Segment Related Income $ 6,316 $ 4,455 $ 8,198 $ 797 $ 580 $ 20,346
</TABLE>
11
<PAGE>
<TABLE>
<CAPTION>
Six Months Ended June 30, 1998
Reportable Segments
-------------------------------------------------------------------------
Municipal Non Mortgage Credit Other Consolidated
Municipal
-------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Origination Written Premiums $ 38,694 $ 12,186 $ 41,238 $ 18,284 $ 7,530 $117,932
Canceled Reinsurance 0 0 0 0 0 0
-------------------------------------------------------------------------
Gross Written Premiums 38,694 12,186 41,238 18,284 7,530 117,932
Net Premiums Written 37,354 12,186 41,161 18,180 7,530 116,411
Net Premiums Earned 19,199 8,763 32,633 14,595 7,767 82,957
Net Underwriting Profit and Other
Segment Related Income $ 13,273 $ 6,723 $ 15,157 $ 2,729 $ 1,952 $ 39,834
</TABLE>
Three Months Ended
June 30,
Reconciliation to Consolidated Results 1999 1998
---------------------------
Net Segment Income ($151,487) $ 20,346
Investment Income and Net Realized
Gains 22,305 17,468
Other Income 1,579 561
Operating Expense, net (6,738) (7,551)
Interest Expense & Minority Int in Subs (3,337) (3,286)
---------------------------
Consolidated Income Before Taxes ($137,678) $ 27,538
---------------------------
Six Months Ended
June 30,
Reconciliation to Consolidated Results 1999 1998
---------------------------
Net Segment Income ($135,216) $ 39,834
Investment Income and Net Realized
Gains 39,877 34,513
Other Income 3,174 937
Operating Expense, net (13,089) (13,319)
Interest Expense & Minority Int in Subs (6,616) (6,599)
---------------------------
Consolidated Income Before Taxes ($111,870) $ 55,366
---------------------------
12
<PAGE>
5. CAPITAL INVESTMENT
In February 1999, ACE Bermuda Insurance Ltd., a subsidiary of ACE Limited,
agreed to invest $75 million in the Corporation through a purchase of common
stock. The proceeds will be used to augment the surplus of the Corporation's
operating subsidiaries. Under the stock purchase agreement, as amended, the
purchase price is $16.95. The transaction closed on June 15, 1999.
6. MERGER
On June 14, 1999 a definitive agreement was executed whereby ACE Limited agreed
to purchase the remaining outstanding shares of the Corporation. The intent to
merge was originally announced on May 27, 1999 and it is expected that the
merger will be completed in the second half of 1999. Under the terms of the
agreement, the Corporation's shareholders would receive 0.6 shares of ACE
Limited for each share of the Corporation at closing, subject to a maximum value
of the Corporation's shareholders of $22 per share. The transaction is subject
to customary regulatory approvals, final approval by Capital Re's shareholders,
confirmation of specified financial strength ratings of the Corporation's
principal operating subsidiaries and other customary conditions.
7. LOSSES
The Corporation reported loss and loss adjustment expenses of $187.9 million as
of June 30,1999. The $187.9 million is principally comprised of (i) an addition
of $45.1 million to incurred losses for reinsurance exposure to certain
asset-backed securities issued by or on behalf of Commercial Financial Services
(the "CFS Securities"). In 1998, the Corporation established a loss reserve in
the amount of $44.1 million for expected losses on this non-municipal financial
guaranty transaction. The increase in losses incurred in 1999 is based on
revised collection estimates on the assets underlying the CFS Securities
following a recently completed transfer of all servicing to the back-up servicer
under the transaction documents. On an ever to date basis, total incurred losses
for the CFS Securities total $90 million; (ii) $74 million for incurred losses
in the financial solutions line of business related to three reinsurance
transactions of International Financial Services Life Insurance Company ("IFS")
that the Corporation secured. This loss represents non-recoverable reinsurance
from IFS relating to reinsurance ceded on certain blocks of single premium and
flexible premium deferred annuities. In the second quarter of 1999, IFS was
placed under an order of rehabilitation by the Missouri insurance authorities.
The order of rehabilitation indicated that a substantial portion of the invested
asset portfolio of IFS, and its affiliates, could not be located and IFS's
ability to pay claims was severely compromised; (iii) $28.5 million of losses in
the financial guaranty line of business of which approximately $14.6 million was
for certain reinsured municipal obligations and approximately $13.9 million for
certain reinsured non-municipal obligations. These financial guaranty loss
reserves were recorded following various events occurring during the second
quarter and evaluated as part of the Corporation's ongoing portfolio
surveillance efforts, (iv) $8.5 million of incurred losses related to the credit
line of business. The addition to the incurred losses was based on an actuarial
review of the trade credit line of business conducted in the second quarter,
which revealed a deficiency in such
13
<PAGE>
reserves associated with certain underwriting years and (v) $6.5 million of
incurred losses for the mortgage line of business. Of that amount, $3.6 million
was recorded after a review of the emerging loss frequency for several
underwriting years covered under a specific excess of loss reinsurance contract.
The balance of the mortgage reserves are associated with paid and incurred
losses consistent with the Corporation's second quarter actuarial review and
analysis of the reinsured mortgage portfolio.
8. OTHER
Interest paid for the six months ended June 30, 1999 and 1998 was $3.6 million
and $3.7 million, respectively.
14
<PAGE>
Management's Discussion and Analysis of Financial Condition and Results of
Operations.
General
Capital Re Corporation (the "Company" or "Capital Re") is an insurance holding
company for a group of reinsurance companies that provide value-added
reinsurance products in several specialty insurance markets. The Company has two
principal divisions: financial guaranty and financial risks. The financial
guaranty division is composed of municipal and non-municipal financial guaranty
reinsurance and credit default swaps. The financial risks division is composed
of mortgage guaranty reinsurance, trade credit reinsurance, title reinsurance
and financial solutions. In both of its divisions, the Company seeks to provide
innovative reinsurance solutions to satisfy the diverse risk and financial
management demands of its clients. The Company believes that its future growth
will be generated through application of its core credit expertise to new
products and markets in its two existing divisions.
The Company participates in its business lines through five wholly-owned
insurance subsidiaries and two joint venture vehicles. Its wholly-owned
subsidiaries are: Capital Reinsurance Company ("Capital Reinsurance"), Capital
Credit Reinsurance Company Ltd. ("Capital Credit"), Capital Mortgage Reinsurance
Company ("Capital Mortgage"), KRE Reinsurance Ltd. ("KRE"), and Capital Title
Reinsurance Company ("Capital Title"). The Company owns a fifty percent economic
interest in ACE Capital Re Ltd. ("ACRE"), a non-consolidated, Bermuda domiciled,
joint venture insurance company. The Company's joint venture partner in ACRE
is-ACE Bermuda Insurance, Ltd. ("ACE Bermuda"), a subsidiary of ACE Limited. The
Company also owns a fifty percent interest in Lenders Residential Asset Company
LLC (formerly, Lenders Mortgage Alliance Company LLC) ("LRAC"), a
non-consolidated Delaware limited liability company. During the Second Quarter
of 1999, the Company completed a reorganization of its operating subsidiaries.
As part of the reorganization Capital Credit was merged into KRE. KRE, the
surviving company, is now a direct wholly-owned subsidiary of the Company.
Capital Mortgage and Capital Title are direct wholly-owned subsidiaries of KRE
and KRE also holds the Company's equity interest in ACRE. In August, 1999, ACE
Bermuda contributed an additional $85 million in equity to ACRE and the
Company's economic interest in ACRE was thereby reduced to 13.4 percent.
The Company's financial guaranty division conducts its business primarily
through Capital Reinsurance. Capital Reinsurance is a professional reinsurance
company dedicated to serving the U.S. domestic and international financial
guaranty insurance markets and has established itself as a leading specialty
reinsurer (by market share) of financial guaranties of investment grade debt
obligations, principally municipal debt obligations. Capital Reinsurance applies
a "zero expected loss" standard to its underwriting process, which is premised
on a general policy of reinsuring only those obligations that are investment
grade on the date reinsured and where there is no expectation of loss on the
risk reinsured. Nevertheless, losses can be expected to occur in Capital
Reinsurance's
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existing and future reinsurance and credit default swap portfolios. At the same
time, consistent with its "zero expected loss" underwriting policies, Capital
Reinsurance has pursued the reinsurance of investment grade non-municipal debt
obligations and directed its capacity to the reinsurance of financial guaranties
of asset-backed securities. In addition, Capital Reinsurance sells municipal and
non-municipal credit risk protection on a facultative basis to a wide variety of
counterparties through credit default swap transactions. Credit default swaps
are underwritten in accordance with the same "zero expected loss" standard that
applies to Capital Reinsurance's municipal and non-municipal financial guaranty
business.
The Company's financial risks division conducts its business primarily through
KRE and its subsidiaries Capital Mortgage and Capital Title (collectively, "KRE
Financial Risks"). KRE Financial Risks is a leading reinsurer of mortgage
guaranty insurance. The mortgage guaranty reinsurance strategy of KRE Financial
Risks is based on the development of creative reinsurance programs targeted to
the individual capital, risk and portfolio management demands of the primary
mortgage guaranty insurers. Mortgage guaranty reinsurance is underwritten with
the expectation that losses will occur regularly.
KRE Financial Risks writes trade credit reinsurance in the U.S. and Europe.
Trade credit insurance protects those who sell goods and services on credit
terms against default by the purchaser on its payment obligations. Trade credit
reinsurance is an extension of the Company's underwriting focus, relying on
credit analysis and portfolio diversification techniques similar to those
employed in financial guaranty and mortgage guaranty reinsurance. Portfolio
losses will also be expected to occur regularly in the Company's trade credit
reinsurance business.
KRE Financial Risks provides title reinsurance designed to aid title insurers in
managing portfolio risk, meeting capital adequacy concerns and to achieve
desired claims-paying ability ratings from nationally recognized rating
agencies. Capital Title offers excess of loss and quota share reinsurance
products on both a treaty and facultative basis. Title reinsurance is
underwritten without the expectation of any significant loss; however, losses
can be expected to occur in the existing and future reinsured title insurance
portfolio.
The financial solutions business of KRE Financial Risks is focused on providing
highly structured solutions to problems of financial and risk management through
reinsurance, including credit enhancement, excess of loss and surplus management
covers. The principle target market is life, accident and health insurers and
reinsurers, although specialty property and casualty markets also provide
opportunities. The underwriting process places significant emphasis on actuarial
analysis. Transactions are underwritten to be risk remote or finite, standards
that are compatible with the Company's "zero expected loss" financial guaranty
underwriting standard. Losses can be expected to occur in the Company's existing
and future financial solutions portfolio.
KRE Financial Risks also assumes financial guaranty risk, both as a
retrocessionaire of Capital Reinsurance and directly from certain primary
financial guaranty insurers.
LRAC provides marketing and consulting services to mortgage lenders with regard
to the origination and closing of residential mortgages and the sale of such
mortgages into the capital
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markets. In addition, by providing direct access to lenders, it generates
markets for the sale of the Company's other products. The Company also owns RGB
Underwriting Agencies Ltd. ("RGB"), a Lloyd's of London ("Lloyd's") managing
agency which presently manages four syndicates operating in the Lloyd's
insurance market, and CRC Capital Ltd. ("CRC Capital"), a corporate name at
Lloyd's, which provides underwriting capacity to the syndicates managed by RGB.
The Company has commenced a plan of divestiture of its Lloyd's operations.
Accordingly, commencing in 1998, the Company began reflecting its participation
in Lloyd's as a discontinued operation. All 1999 and prior year figures
presented herein reflect Lloyd's as a discontinued operation.
The Capital Re corporate group also includes Capital Re Solutions Incorporated
(formerly, Capital Re Management Company), a New York reinsurance intermediary,
ACE Capital Re Managers Ltd., a Bermuda based management company, and Capital Re
LLC, a Turks & Caicos Islands finance subsidiary organized in 1993 to issue $75
million of Company guaranteed mandatorily redeemable preferred stock, the
proceeds of which were loaned to Capital Re. Capital Re Financial Products
Company, a newly formed Delaware business Company, and Capital Risk Assurance
Company ("Capital Risk"), a Maryland surety insurer.
Results of Operations
Three Months Ended June 30, 1999 versus Three Months Ended June 30, 1998
The Company recorded a ($89.6) million net loss from continuing operations for
the three months ended June 30, 1999. For the same period of 1998, the Company
recorded net income from continuing operations of $19.1 million. On a per share
basis, the basic and diluted net loss from continuing operations were ($2.73)
and ($2.70), respectively, for the three months ended June 30, 1999. For the
same period of 1998, on a per share basis, basic and diluted net income from
continuing operations were $0.60 and $0.58, respectively. The losses for the
1999 period are primarily attributable to loss reserve additions for specific
reinsured transactions and portfolio exposures.
The Company recorded a ($106.8) million net loss including loss from
discontinued operations for the three months ended June 30, 1999. For the same
period of 1998, the Company recorded net income including income from
discontinued operations of $20.2 million. On a per share basis, both basic and
diluted net income including loss from discontinued operations were ($3.26) and
($3.22), respectively. These losses were primarily attributable to the additions
to loss reserves described above as well as negative results from the Company's
discontinued Lloyd's operations. For the same period of 1998, on a per share
basis, both basic and diluted net income including income from discontinued
operations were $0.63 and $0.61, respectively.
Origination premiums written (i.e., gross premiums written before canceled
reinsurance) increased 8.6% to $60.6 million for the three months ended June 30,
1999 from $55.8 million for the same period of 1998. Non-municipal origination
premiums written increased to $10.1 million for the three months ended June 30,
1999 from $6.2 million for the three months ended June 30, 1998 due to a
significant increase in premiums written in the credit default swaps sector of
that business. A credit default swap is a transaction whereby one counterparty
pays a periodic fee in fixed basis points on a notional amount in return for a
contingent payment by the other counterparty in the event one or more
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<PAGE>
defined credit events occurs with respect to one or more third party reference
securities or loans. A credit event is generally defined as a failure to pay,
bankruptcy, cross acceleration (generally accompanied by a failure to pay),
repudiation, restructuring, or similar nonpayment event. Credit default swap
premium grew to $5.2 million for the three months ended June 30, 1999 from $1.5
million in the prior year. Mortgage guaranty reinsurance premium increased to
$24.5 million in the second quarter of 1999 compared to $21.0 million in the
second quarter of 1998 because of a large excess of loss reinsurance transaction
recorded in the second quarter of 1999. The following table shows origination
premiums written by line of business for the three months ended June 30, 1999
and June 30, 1998.
Origination Premiums Written
Three Months Ended
June 30,
1999 1998
---- ----
(dollars in millions)
Financial Guaranty Division:
Municipal $13.2 $16.5
Non-Municipal 10.1 6.2
Financial Risks Division:
Mortgage 24.5 21.0
Credit 8.1 9.8
Financial Solutions 3.3 1.4
Title 1.4 0.9
----- -----
Total Origination
Premiums Written $60.6 $55.8
Net premiums written increased by 7.2% to $59.4 million for the three months
ended June 30, 1999 from $55.4 million for the same period of 1998. This
increase is commensurate with the explanation described above for the increase
in origination premium. The following table shows net premiums written by line
of business for the three months ended June 30, 1999 and June 30, 1998.
Net Premiums Written
Three Months Ended
June 30,
1999 1998
---- ----
(dollars in millions)
Financial Guaranty Division:
Municipal $12.2 $16.1
Non-Municipal 10.0 6.2
Financial Risks Division:
Mortgage 24.5 21.0
Credit 8.0 9.8
Financial Solutions 3.3 1.4
Title 1.4 0.9
----- -----
Total Net
Premiums Written $59.4 $55.4
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For the three months ended June 30, 1999, net premiums earned increased 2.0% to
$40.0 million from $39.2 million for the comparable 1998 period. For the three
months ended June 30, 1999 and June 30 1998, ceded earned premium was $3.7
million and $3.6 million, respectively. The following table shows net premiums
earned by line of business for the three months ended June 30, 1999 and June 30,
1998.
Net Premiums Earned
Three Months Ended
June 30,
1999 1998
(dollars in millions)
Financial Guaranty Division:
Municipal $ 5.8 $ 9.7
Non-Municipal 8.0 4.8
Financial Risks Division:
Mortgage 12.8 14.7
Credit 8.5 7.4
Financial Solutions 3.3 1.4
Title 1.6 1.0
----- -----
Total Net
Premiums Earned $ 40.0 $ 39.2
For the three months ended June 30, 1999, net investment income increased 9.3%
to $17.7 million from $16.2 million for the comparable period of 1998. Growth in
investment income was primarily attributable to a larger investment portfolio
caused by an increase in invested assets from positive operating cash flows
during the twelve months ended June 30, 1999. The Company recognized net
realized gains of $4.6 million for the three months ended June 30, 1999 compared
to $1.3 million for the same period of 1998.
Loss and loss adjustment expenses increased to $175.1 million from $2.6 million
for the three months ended June 30, 1999 and 1998, respectively. The $175.1
million is principally comprised of (i) an addition of $45.1 million to incurred
losses for reinsurance exposure to certain asset-backed securities issued by or
on behalf of Commercial Financial Services (the "CFS Securities"). In 1998, the
Company established a loss reserve in the amount of $44.1 million for expected
losses on this non-municipal financial guaranty transaction. The increase in
losses incurred in 1999 is based on revised collection estimates on the assets
underlying the CFS Securities following a recently completed transfer of all
servicing to the back-up servicer under the transaction documents. On an ever to
date basis, total incurred losses for the CFS Securities total $90 million; (ii)
$74 million for incurred losses in the financial solutions line of business
related to three reinsurance transactions of International Financial Services
Life Insurance Company ("IFS") that the Company secured. This loss represents
non-recoverable reinsurance from IFS relating to reinsurance ceded on certain
blocks of single premium and flexible premium deferred annuities. In the second
quarter of 1999, IFS was placed under an order of rehabilitation by the Missouri
insurance authorities. The order of rehabilitation indicated that a substantial
portion of the invested asset portfolio of IFS, and its affiliates, could not be
located and IFS's ability to pay claims was severely compromised; (iii) $28.5
million of losses in the financial guaranty line of business of which
approximately $14.6
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million was for certain reinsured municipal obligations and approximately $13.9
million for certain reinsured non-municipal obligations. These financial
guaranty loss reserves were recorded following various events occurring during
the second quarter and evaluated as part of the Company's ongoing portfolio
surveillance efforts, (iv) $8.5 million of incurred losses related to the credit
line of business. The addition to the incurred losses was based on an actuarial
review of the trade credit line of business conducted in the second quarter,
which revealed a deficiency in such reserves associated with certain
underwriting years and (v) $6.5 million of incurred losses for the mortgage line
of business. Of that amount, $3.6 million was recorded after a review of the
emerging loss frequency for several underwriting years covered under a specific
excess of loss reinsurance contract. The balance of the mortgage reserves are
associated with paid and incurred losses consistent with the Company's second
quarter actuarial review and analysis of the reinsured mortgage portfolio. Ceded
losses for the three months ended March 31, 1999 and 1998 were ($50.4) and $0.6
million, respectively.
Total expenses, excluding loss and loss adjustment expenses, decreased 2.4% to
$26.5 million for the three months ended June 30, 1999 from $27.1 million for
the same period of 1998. This decrease was primarily attributable to incentive
compensation related expenses accrued in the second quarter of 1998 in the
amount of $1.3 million that are no longer expected to be incurred. Net expenses
related to this incentive compensation were reversed in the fourth quarter of
1998. As such, no additional expense has been accrued in 1999. The decrease in
total expenses excluding losses was partially offset by investment banking fees
in the amount of $1.0 million incurred in connection with the Company's pending
merger with ACE Limited. (See "Liquidity and Capital Resources"). The decrease
was also due to a one time adjustment recorded in the second quarter of 1998 in
the amount of $5.8 million to reclassify expenses to profit commission expense
from losses incurred based on the terms of an in-force reinsurance contract. The
expense ratios for the three months ended June 30, 1999 and 1998 were 57.2% and
59.7%, respectively.
For the three months ended June 30, 1999, the Company recorded federal taxes
recoverable of $48.1 million. This was as a result of the significant losses
incurred described above. For the three months ended June 30, 1998, the Company
recorded federal income taxes payable of $7.9 million.
Six Months Ended June 30, 1999 versus Six Months Ended June 30, 1998
The Company recorded a ($70.2) million net loss from continuing operations for
the six months ended June 30, 1999. For the same period of 1998, the Company
recorded net income from continuing operations of $40.0. On a per share basis,
the basic and diluted net loss from continuing operations were ($2.17) and
($2.14), respectively, for the six months ended June 30, 1999. For the same
period of 1998, on a per share basis, basic and diluted net income from
continuing operations were $1.25 and $1.21, respectively. The losses for the
1999 period are primarily attributable to additions to loss reserves on specific
reinsured transactions as well as portfolio exposures.
The Company recorded a ($93.9) million net loss including loss from discontinued
operations for the six months ended June 30, 1999. For the same period of 1998,
the Company recorded net income including income from discontinued operations of
$40.0 million. On a per share basis, both basic and diluted net income including
loss from discontinued operations were ($2.90) and ($2.87), respectively. These
losses were primarily attributable to the additions to loss reserves described
above as well as negative results from the Company's discontinued Lloyd's
operations. For the same period of 1998, on a per share basis, both
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<PAGE>
basic and diluted net income including income from discontinued operations were
$1.26 and $1.21, respectively.
Origination premiums written (i.e., gross premiums written before canceled
reinsurance) increased 1.0% to $119.0 million for the six months ended June 30,
1999 from $117.9 million for the same period of 1998. Non-municipal origination
premiums written increased to $22.4 million for the six months ended June 30,
1999 from $12.2 million for the six months ended June 30, 1998 due to a
significant increase in premiums written in the credit default swaps sector of
that business. A credit default swap is a transaction whereby one counterparty
pays a periodic fee in fixed basis points on a notional amount in return for a
contingent payment by the other counterparty in the event one or more defined
credit events occurs with respect to one or more third party reference
securities or loans. A credit event is generally defined as a failure to pay,
bankruptcy, cross acceleration (generally accompanied by a failure to pay),
repudiation, restructuring, or similar nonpayment event. Credit default swap
premium grew to $9.0 million for the six months ended June 30, 1999 from $2.1
million in the prior year. Mortgage guaranty reinsurance premium decreased to
$36.6 million for the six months ended June 30, 1999 compared to $41.2 million
in the second quarter of 1998. This decrease was due to an increase in mortgage
prepayments caused by lower interest rates as well as the Company's shift from
assuming quota share mortgage guaranty reinsurance business toward assuming
structured excess of loss mortgage guaranty reinsurance business. The following
table shows origination premiums written by line of business for the six months
ended June 30, 1999 and June 30, 1998.
Origination Premiums Written
Six Months Ended
June 30,
1999 1998
(dollars in millions)
Financial Guaranty Division:
Municipal $ 33.6 $ 38.7
Non-Municipal 22.4 12.2
Financial Risks Division:
Mortgage 36.6 41.2
Credit 17.2 18.3
Financial Solutions 6.0 5.5
Title 3.2 2.0
------ ------
Total Origination
Premiums Written $119.0 $117.9
Net premiums written decreased by 8.7% to $106.3 million for the six months
ended June 30, 1999 from $116.4 million for the same period of 1998. This
decrease is primarily attributable to $9.6 million in canceled reinsurance
resulting from the cancellation of a large non-municipal financial
21
<PAGE>
guaranty transaction. The following table shows net premiums written by line of
business for the six months ended June 30, 1999 and June 30, 1998.
Net Premiums Written
Six Months Ended
June 30,
1999 1998
---- ----
(dollars in millions)
Financial Guaranty Division:
Municipal $ 31.7 $ 37.4
Non-Municipal 11.8 12.2
Financial Risks Division:
Mortgage 36.6 41.2
Credit 17.0 18.2
Financial Solutions 6.0 5.5
Title 3.2 2.0
------ ------
Total Net
Premiums Written $106.3 $116.4
For the six months ended June 30, 1999, net premiums earned decreased slightly
to $82.6 million from $83.0 million for the comparable 1998 period. For the six
months ended June 30, 1999 and June 30 1998, ceded earned premium was $7.5
million and $7.4 million, respectively. The following table shows net premiums
earned by line of business for the six months ended June 30, 1999 and June 30,
1998.
Net Premiums Earned
Six Months Ended
June 30,
1999 1998
---- ----
(dollars in millions)
Financial Guaranty Division:
Municipal $ 15.4 $ 19.2
Non-Municipal 14.7 8.9
Financial Risks Division:
Mortgage 25.6 32.6
Credit 17.5 14.6
Financial Solutions 6.0 5.5
Title 3.4 2.2
------ ------
Total Net
Premiums Earned $ 82.6 $ 83.0
For the six months ended June 30, 1999, net investment income increased 8.4% to
$34.8 million from $32.1 million for the comparable period of 1998. Growth in
investment income was primarily attributable to a larger investment portfolio
caused by an increase in invested assets from positive operating cash flows
during the twelve months ended June 30, 1999. The Company recognized net
22
<PAGE>
realized gains of $5.0 million for the six months ended June 30, 1999 compared
to $2.5 million for the same period of 1998.
Loss and loss adjustment expenses increased to $187.9 million from $12.6 million
for the six months ended June 30, 1999 and 1998, respectively. The $187.9
million is principally comprised of:
o An addition of $45.1 million to incurred losses for reinsurance exposure to
certain asset-backed securities issued by or on behalf of Commercial
Financial Services (the "CFS Securities"). In 1998, the Company established
a loss reserve in the amount of $44.1 million for expected losses on this
non-municpal financial guaranty transaction. The increase in losses
incurred in 1999 is based on revised collection estimates on the assets
underlying the CFS Securities following a recently completed transfer of
all servicing to the back-up servicer under the transaction documents. On
an ever to date basis, total incurred losses for the CFS Securities total
$90 million;
o $74 million for incurred losses in the financial solutions line of business
related to three reinsurance transactions of International Financial
Services Life Insurance Company ("IFS") that the Company secured. This loss
represents the counterparties estimated non-recoverable reinsurance from
IFS relating to reinsurance ceded on certain blocks of single premium and
flexible premium deferred annuities. In the second quarter of 1999, IFS was
placed under an order of rehabilitation by the Missouri insurance
authorities. The order of rehabilitation indicated that a substantial
portion of the invested asset portfolio of IFS, and its affiliates, could
not be located and IFS's ability to pay claims was severely compromised;
o $28.5 million of losses in the financial guaranty line of business of which
approximately $14.6 million was for certain reinsured municipal obligations
and approximately $13.9 million for certain reinsured non-municipal
obligations. These financial guaranty loss reserves were recorded following
various events occurring during the second quarter and evaluated as part of
the Company's ongoing portfolio surveillance efforts;
o $8.5 million of incurred losses related to the credit line of business. The
addition to the incurred losses was based on an actuarial review of the
trade credit line of business conducted in the second quarter, which
revealed a deficiency in such reserves associated with certain underwriting
years; and
o $6.5 million of incurred losses for the mortgage line of business. Of that
amount, $3.6 million was recorded after a review of the emerging loss
frequency for several underwriting years covered under a specific excess of
loss reinsurance contract. The balance of the mortgage reserves are
associated with paid and incurred losses consistent with the Company's
second quarter actuarial review and analysis of the reinsured mortgage
portfolio. Ceded losses for the six months ended June 30, 1999 and 1998
were $(50.4) million and $1.1 million, respectively.
Total expenses, excluding loss and loss adjustment expenses, decreased 1.6% to
$49.6 million for the six months ended June 30, 1999 from $50.4 million for the
same period of 1998. This decrease was
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<PAGE>
primarily attributable to incentive compensation related expenses accrued in the
second quarter of 1998 in the amount of $1.8 million that are no longer expected
to be incurred. Net expenses related to this incentive compensation were
reversed in the fourth quarter of 1998. As such, no additional expense has been
accrued in 1999. The decrease in total expenses excluding losses was partially
offset by investment banking fees in the amount of $1.0 million incurred in
connection with the Company's pending merger with ACE Limited. (See Liquidity
and Capital Resources.). The decrease was also due to a one time adjustment
recorded in the second quarter of 1998 in the amount of $5.8 million to
reclassify expenses to profit commission expense from losses incurred based on
the terms of an inforce reinsurance contract. The expense ratios for the six
months ended June 30, 1999 and 1998 were 51.2% and 52.8%, respectively.
For the six months ended June 30, 1999, the Company recorded federal taxes
recoverable of $41.7 million. This was as a result of the significant losses
incurred described above. For the six months ended June 30, 1998, the Company
recorded federal income taxes payable of $15.4 million.
Liquidity and Capital Resources
The Company relies on dividends from Capital Reinsurance and KRE to fund its
payment of dividends on its capital stock and interest on its outstanding debt.
The major sources of liquidity for Capital Reinsurance are funds generated from
reinsurance premiums, net investment income and maturing investments. Capital
Reinsurance is domiciled in the State of Maryland, and, under Maryland insurance
law, the amount of the surplus of Capital Reinsurance available for distribution
as dividends is subject to certain statutory restrictions. The amount available
for distribution from Capital Reinsurance during 1999 with notice to, but
without prior approval of, the Maryland Insurance Commissioner is limited to 10%
of Capital Reinsurance's policyholders' surplus as of December 31, 1998, or
approximately $32.3 million. For the six months ended June 30, 1999, Capital
Reinsurance paid dividends in the amount of $5.0 million to the Company.
KRE's major sources of liquidity are funds generated from reinsurance premiums,
net investment income and maturing investments. KRE, is a Bermuda domiciled
insurer whose distributions are governed by Bermuda law. Under Bermuda law and
the by-laws of KRE, dividends may be paid out of the profits of the company
(defined as accumulated realized profits less accumulated realized losses).
Distributions to shareholders may also be paid out of KRE's surplus limited by
requirements that such company must at all times (i) maintain the minimum share
capital required under Bermuda law and (ii) have relevant assets in an amount
equal to or greater than 75% of relevant liabilities, all as defined under
Bermuda law. During 1999, KRE has paid no dividends to the Company.
Capital Mortgage, a wholly owned subsidiary of KRE, is subject to the dividend
restrictions imposed under New York insurance law. Accordingly, dividends may
only be declared and distributed out of
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<PAGE>
earned surplus (as defined under New York insurance law). Additionally, no
dividend may be declared or distributed by Capital Mortgage in an amount which,
together with all dividends declared or distributed by Capital Mortgage during
the preceding twelve months, exceeds the lesser of 10% of such company's surplus
to policyholders as shown by its last Annual Statutory Statement on file with
the New York insurance department, or 100% of adjusted net investment income (as
defined under New York insurance law) during such period, unless, upon prior
application, the New York Superintendent of Insurance approves a greater
dividend distribution based upon his finding that Capital Mortgage will retain
sufficient surplus to support its obligations and writings. To date, Capital
Mortgage has not declared nor paid any dividends. The maximum dividend payable
by Capital Mortgage during 1999 is $0 since its earned surplus was ($9.2)
million as of December 31, 1998.
Capital Title, also a wholly owned subsidiary of KRE, is subject to the New York
insurance laws and regulations governing title insurers. Accordingly, dividends
may only be declared and distributed out of earned surplus as defined under New
York insurance law and only if such dividends do not reduce the company's
surplus to less than 50% of its outstanding capital shares, i.e., the value of
its outstanding common equity. Additionally, no dividend may be declared or
distributed in an amount which, together with all dividends declared or
distributed by the company during the preceding twelve months, exceeds 10% of
the company's outstanding capital shares, unless, after deducting such
dividends, it has a surplus at least equal to 50% of its statutory reinsurance
reserve or a surplus at least equal to $250,000, whichever is greater. As of
December 31, 1998, Capital Title's maximum amount payable as a dividend during
1999 is approximately $3.6 million. During 1999, Capital Title has paid no
dividends.
In January 1994, the Company formed and capitalized, through the purchase of
common shares, Capital Re LLC. Capital Re LLC exists solely for the purpose of
issuing preferred and common shares and lending the proceeds of such issuance to
the Company to fund its business operations. In January 1994, Capital Re LLC
issued $75.0 million of company obligated mandatorily redeemable preferred
securities, the proceeds of which were loaned to the Company. The Company has,
among other undertakings, unconditionally guaranteed all legally declared and
unpaid dividends of Capital Re LLC. The company obligated mandatorily redeemable
preferred securities were issued at $25 par value per share and pay monthly
dividends at a rate of 7.65% per annum.
For the six months ended June 30, 1999, the Company declared and paid common
dividends in the amount of $2.7 million or $0.08 per share.
The Company reorganized its operating subsidiaries during the second quarter of
1999. As a result, KRE has become a direct wholly-owned subsidiary of the
Company. Capital Mortgage and Capital Title are now wholly-owned subsidiaries of
KRE and KRE owns all of the Company's equity interest in ACRE. As part of the
reorganization, approximately $137.0 million was transferred from Capital
Mortgage to KRE and KRE assumed certain reinsurance liabilities from Capital
Mortgage.
Cash flows from operations for the six months ended June 30, 1999 and 1998,
consisting of reinsurance premiums collected net of expenses, investment income
and income taxes, were $37.6 million and $44.4 million, respectively. The
Company believes that current levels of cash flow from operations provide the
Company with sufficient liquidity to meet its operating needs. The
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<PAGE>
Company's non-operating cash outflows are primarily dedicated to (i)
fixed-income investment activity, (ii) the payment of dividends on its common
shares, (iii) payments of interest on long-term debt and (iv) the payment of its
loan obligations to Capital Re LLC.
At June 30, 1999, cash and investments were approximately $1.25 billion, an
increase of $64.2 million, or 5.4%, from $1.18 billion at December 31, 1998. In
managing its investment portfolio, the Company places a high priority on quality
and liquidity. As of June 30, 1999, the entire investment portfolio was invested
in highly rated fixed income securities.
At June 30, 1999, approximately $195.1 million, or 15.6%, of the Company's
investment portfolio was composed of mortgage-backed securities ("MBS"). Of the
MBS portfolio, approximately $167.9 million, or 86.1%, is backed by agencies or
entities sponsored by the U.S. government as to the full amount of principal and
interest. As of June 30, 1999, the entire MBS portfolio was invested in triple A
rated securities. Prepayment risk is an inherent risk of holding MBS. However,
the degree of prepayment risk is particular to the type of MBS held. The Company
limits its exposure to prepayments by purchasing less volatile types of MBS. As
of June 30, 1999, $3.6 million, or approximately 1.8%, of the MBS portfolio was
invested in collateralized mortgage obligations ("CMOs") which are characterized
as planned amortization class CMOs ("PACs"). PACs are securities whose cash
flows are designed to remain constant over a variety of mortgage prepayment
environments. Other classes in the CMO security are structured to accept the
volatility of mortgage prepayment changes, thereby insulating the PAC class. Of
the remaining MBS portfolio, $191.6 million, or 98.2%, was invested in
mortgage-backed pass-throughs or sequential CMOs. Pass-throughs are securities
in which the monthly cash flows of principal and interest (both scheduled and
prepayments) generated by the underlying mortgages are distributed on a pro-rata
basis to the holders of securities. A sequential MBS is structured to divide the
CMO security into sequentially ordered classes. Receipt of principal payments
within classes is contingent on the retirement of all previously paying classes.
Generally, interest payments are made currently on all classes. While these
securities are more sensitive to prepayment risk than PACs, they are not
considered highly volatile securities. While the Company may consider investing
in any tranche of a sequential MBS, the individual security's characteristics
(duration, relative value, underlying collateral, etc.) along with aggregate
portfolio risk management determine which tranche of sequential MBS will be
purchased. At June 30, 1999, the Company had no securities such as interest only
securities, principal only securities, or MBS purchased at a substantial premium
to par that have the potential for loss of a significant portion of the original
investment due to changes in the prepayment rate of the underlying loans
supporting the security.
Capital Reinsurance is party to a credit facility with Deutsche Bank AG (the "DB
Credit Facility") pursuant to which Deutsche Bank AG provides up to $100.0
million specifically designed to provide rating agency qualified capital to
further support Capital Reinsurance's claims-paying resources. This agreement
expires January 27, 2006. Capital Reinsurance has not borrowed under the DB
Credit Facility. The Company is also party to a liquidity facility with Deutsche
Bank AG, pursuant to which Deutsche Bank provides up to $30 million for general
corporate purposes. The Company has not borrowed under this liquidity facility.
The liquidity facility expires January 21, 2000.
26
<PAGE>
In addition, on August 20, 1996, the Company entered into a credit agreement
with Chase Manhattan Bank for the provision of a $25.0 million credit facility
(the "Chase Facility") which is available for general corporate purposes.
Furthermore, on August 26, 1996, the Company utilized $16 million of the Chase
Facility for purposes of paying subordinated notes that came due. Interest on
the bank note issued under the Chase Facility is payable quarterly based upon
the Company's chosen interest rate option under the terms of the Chase Facility.
In November 1996, the Company utilized the remaining $9 million of the Chase
Facility for purposes of acquiring RGB. Under the terms of the Chase Facility,
borrowed principal in the amount of $25 million becomes payable in full on
October 16, 1999.
On March 10, 1999, Moody's Investors Service, Inc. ("Moody's") announced that it
had downgraded the financial strength rating of Capital Reinsurance to Aa2 from
Aaa. This action ended a review process that began on November 5, 1998. Moody's
cited increased competition in the monoline financial guaranty reinsurance
industry, an increased risk profile in business assumed and rising operating
leverage as reasons for the downgrade. Under certain of its reinsurance
agreements with two of its financial guaranty ceding companies, Capital
Reinsurance has agreed to increase the ceding commission payable under such
agreements as a result of the rating action by Moody's. The increase applies to
in-force and future business ceded by those companies. The Company expects total
additional ceding commission expense to total approximately $11.8 million. Of
the $11.8 million, $5.6 million was paid in the second quarter of 1999. The
expected additional ceding commission will be amortized as the related
reinsurance premium is earned. The reinsurance agreements with the two ceding
companies also give those companies an option to reassume business previously
ceded to Capital Reinsurance upon certain adverse rating actions; however, those
options to fully reassume were not triggered by Capital Reinsurance's March 10th
downgrade. Additionally, one of the ceding companies may reassume a minor
portion of its previously ceded business based on this rating action alone;
however, that company has not indicated that it will exercise the option.
On December 16, 1998, Standard & Poor's ("S&P") affirmed the triple A financial
strength rating of Capital Reinsurance. In addition, on April 28, 1999 S&P
affirmed the financial strength ratings of Capital Mortgage (double "A"), KRE
(double "A") and Capital Credit (single "A" plus). S&P also upgraded the
financial strength rating of Capital Title from double "A" minus to double "A".
On June 15, 1999, ACE Bermuda Insurance Ltd., a subsidiary of ACE Limited
("ACE"), invested $75 million in the Company through a purchase of common stock.
The proceeds were used to support the Company's ongoing business activity. ACE's
investment is equal to approximately 12% of the Company.
In addition, on June 10, 1999, a definitive agreement was executed whereby ACE
agreed to purchase the remaining outstanding shares of the Company. The
definitive agreement followed a binding letter of intent to merge which was
executed on May 27, 1999. It is expected that the merger will be completed in
the second half of 1999. Under the terms of the agreement, the Company's
shareholders would receive 0.6 shares of ACE for each share of the Company at
closing, subject to a maximum value of the Company's shareholders of $22 per
share. The transaction is subject to customary regulatory approvals, final
approval by Capital Re's
27
<PAGE>
shareholders, confirmation of specified financial strength ratings of the
Company's principal operating subsidiaries and other customary conditions.
Market Risk
The main objectives in managing the investment portfolios of the Company and its
operating subsidiaries are to maximize after-tax investment income and total
investment returns while minimizing credit risks in order to provide maximum
support to the reinsurance underwriting operations. Investment strategies are
developed based on many factors including underwriting results and the Company's
resulting tax position, regulatory requirements, fluctuations in interest rates
and consideration of other market risks. Investment decisions are managed by
outside investment professionals under discretionary investment management
agreements and based on guidelines established by management and approved by the
board of directors.
Market risk represents the potential for loss due to adverse changes in the fair
value of financial instruments. The market risks related to financial
instruments of the Company and its operating subsidiaries primarily relate to
the investment portfolio, which exposes the Company to risks related to interest
rates and, to a lesser extent, credit quality and prepayment. Analytical tools
and monitoring systems are in place to assess each of these elements of market
risk.
Interest rate risk is the price sensitivity of a fixed income security to
changes in interest rates. Management views these potential changes in price
within the overall context of asset and liability management. Wherever possible,
the duration of asset and liability portfolios are matched. However, the
duration of most of the asset portfolio is managed according to the level of
expected return and volatility deemed tolerable by management. The duration of
the liability portfolio does not lend itself to active duration management due
to the low frequency, high severity losses in a majority of the Company's
reinsured businesses. Other factors are considered in determining the duration
of the asset portfolio, which the Company believes mitigates the overall effect
of interest risk for the Company.
The following table provides information about the Company's fixed maturity
investments at June 30, 1999 that are sensitive to changes in interest rates.
The table presents cash flows of principal amounts and related weighted average
interest rates by expected maturity dates. The cash flows are based on the
earlier of the call date or the maturity date or, for mortgage-backed
securities, expected payment patterns. Actual cash flows could differ from the
expected amounts.
28
<PAGE>
Long-term Fixed Maturities
Expected Cash Flows of Principal Amounts
(Dollars in millions)
<TABLE>
<CAPTION>
Amortized Market
1999 2000 2001 2002 2003 Thereafter Cost Value
---- ---- ---- ---- ---- ---------- ---- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Tax-exempt $ 0.0 $ 1.8 $ .8 $ 6.3 $ 18.0 $ 455.6 $ 482.5 $ 490.9
Average Interest Rate 0.0% 5.7% 6.3% 7.3% 7.2% 5.7% -- --
Taxable-other than 10.6 45.1 46.4 57.3 28.4 228.4 416.2 407.3
mortgage-backed securities
Average Interest Rate 7.0% 6.4% 7.5% 6.4% 6.5% 5.6% -- --
Mortgage-backed securities 12.7 22.7 19.9 17.7 17.1 108.1 198.2 195.1
Average Interest Rate 7.0% 6.9% 6.9% 6.8% 6.8% 6.7% -- --
------- ------- ------- ------- ------- -------- -------- --------
Total $ 23.3 $ 69.6 $ 67.1 $ 81.3 $ 63.5 $ 792.1 $1,096.9 $1,093.3
------- ------- ------- ------- ------- -------- -------- --------
</TABLE>
The Company and its operating subsidiaries have consistently invested in high
quality marketable securities. As a result, the Company believes that it has
minimal credit quality risk. Taxable bonds in the Company's domestic portfolio
consist of U.S. Treasury, government agency, mortgage-backed and corporate
securities. At June 30, 1999, approximately 22.0% of taxable bonds were issued
by the U.S. Treasury or U.S. government agencies and approximately 70.4% were
rated AA or better by Moody's or S&P. Of the tax exempt bonds, approximately
97.9% were rated AA or better with more than 81.7% rated AAA. Less than 1.4% of
the Company's bond portfolio was below investment grade at June 30, 1999. At
June 30, 1999, both taxable and tax exempt bonds had a weighted average maturity
of approximately 9.71 years.
The Company's taxable bond portfolio includes mortgage-backed securities, which
comprised 32.4% of the portfolio at June30, 1999. Prepayment risk refers to the
changes in prepayment patterns that can either shorten or lengthen the expected
timing of the principal repayments and thus the average life and the effective
yield of a security. Such risk exists primarily within the Company's portfolio
of mortgage-backed securities. The Company invests primarily in those classes of
mortgage-backed securities that are less subject to prepayment risk.
All of the above risks are monitored on an ongoing basis. A combination of
in-house systems and proprietary models and externally licensed software are
used to analyze individual securities as well as each portfolio. These tools
provide management with information to assist them in the evaluation of the
market risks of the portfolio.
The Year 2000
The Company is actively pursuing its Year 2000 analysis and preparation. The
Year 2000 issue involves potential complications related to computer systems,
machinery and electronics that
29
<PAGE>
contain computer code, whether in software or embedded within microchips, that
recognize years in two digit code, e.g. "98" for the year 1998. Software or
microchips that recognize the Year 2000 as "00" or any year thereafter in its
two digit equivalent, threatens date sensitive calculations by potentially
misapplying the date (e.g. "00" could be applied as 1900 rather than 2000). Any
coding that causes a date recognition error of this sort is commonly referred to
as a Year 2000 bug.
STATE OF READINESS
The Company has assembled a team consisting of officers and employees of the
finance and information systems departments to oversee the Company's readiness
for the Year 2000. The group has already completed the first phase of its
analysis in which a comprehensive list of all the Company's own information
technology systems and general technology was prepared. Additionally, the
Company's clients and vendors were reviewed and a listing was prepared of those
with information systems or other technology upon which the Company may rely and
those which may be affected by the Year 2000 bug. The Company has made inquiries
as to Year 2000 readiness with these clients and vendors and has received
responses from a majority of them. It is currently evaluating these responses.
However, all of the Company's ceding companies that have thus far responded
report that they expected to be Year 2000 compliant by mid 1999. The Company is
now performing testing and remediation, as necessary, on its information
technology systems, its general systems and any other technology that may be
affected by the Year 2000 bug. This process is not yet complete, but is expected
to be completed by mid-1999.
The following is a summary of the Company's internal readiness status:
In-house Applications: All key in-house applications have been tested and are
Year 2000 compliant.
Accounting Software: Vendors for the major accounting software packages used by
the Company have stated that the software versions the Company uses are Year
2000 compliant.
Administration/Human Resources; Operating System Software; Network/Lan
Utilities; Desktop Hardware: Ninety-five percent of these applications are Year
2000 compliant.
General Office Services:. These systems will all be upgraded by mid-1999.
The Company has not had to defer any of its expected information technology or
other technology installations, updates or enhancements in order to accommodate
its Year 2000 review and remediation work.
Costs
Due to the youthfulness of the Company's information technology and other
systems, testing and remediation have been fairly uncomplicated. Moreover, none
of the Company's technology is
30
<PAGE>
mainframe computer based. Mainframes traditionally use older coding
methodologies and, thus, are more likely to be double digit dated coded. No
external consultants have been retained. Internal information technology
personnel have overseen and implemented the testing and remediation of the
systems and technology. The amount of additional time allocable to employees'
efforts has been nominal. All system upgrade costs incurred would have been
incurred by the Company as part of routine software upgrades and all patches
have been provided without any material cost to the Company. The Company does
not expect any material additional costs and expects that, including the cost
allocation of internal personnel, the overall testing and remediation will be
less than $50,000 as originally anticipated. The costs are being funded through
operating cash flows and will be expensed as incurred.
The Risk of the Company's Year 2000 Issues
A Year 2000 bug issue may manifest itself as (i) a failure of the Company's
software, systems and general technology, (ii) a failure of a client's or
vendor's software or systems which would impact the Company, and (iii) insurance
claims against the Company due to Year 2000 issues. Management believes that the
likelihood that a failure of the Company's software and systems would have a
material effect on the business of the Company is minimal. The information
technology and other systems are not critical to the carrying-on of the
Company's business. Additionally, all critical accounting, financial reporting
and human resources functions can be maintained on a manual basis for a period
of time without materially impeding the operations of the Company. Similarly, a
failure of clients and vendors to properly provide data or services will also
not materially affect the Company's ability to continue its operations. Such a
failure would likely be temporary and could be compensated for in the short-term
by using manual alternatives to tracking business with our clients or vendors.
Reinsurance losses pose the most reasonably likely worst case scenario for the
Company arising out of Year 2000 bugs. The issue would originate with a default
on debt service obligations of bond issuers due to the issuer's own Year 2000
bug difficulties. In the event of such a default, the Company's clients, the
ceding companies, will be required to make debt service payments on behalf of
the defaulting issuers. The Company will have to make prompt payment to its
clients for its agreed upon portion of such losses. Such defaults by bond
issuers would generally be of a technical nature, arising out of temporary
inabilities to process payments or calculate payment amounts. Additionally, the
defaulted debt service obligations would generally not require our clients, the
ceding insurers, to make debt service payments on behalf of the issuers for a
prolonged period. Once issuers or payment agents have cured any errors, they
would resume debt service payment and reimburse the insurers for all payments
made. Hence, the reasonable worst case scenario for the Company under such
circumstances would involve liquidity pressure which should ease quickly. There
is no way to quantify the potential exposure under this scenario as there has
never been any event similar to the Year 2000. Consequently, it is difficult to
make assumptions based on the Company's business. However, as the Company's
operating units affected by such an occurrence already meet the rating agency
stress test requirements designed to simulate depression-era conditions, the
Company believes it can withstand temporary defaults of that magnitude based on
the Year 2000 bug.
31
<PAGE>
Contingency Plans
The Company does not have a prescribed contingency plan relative to Year 2000
bug issues. The Company does not predict that a failure of its information
technology systems will materially affect daily operations or have an immediate
impact on the Company's ability to conduct business. All internal financial
reporting of the Company may be conducted by hand. As for any failure of a bond
issuer that has been reinsured by the Company, the Company expects to handle
such matters in the ordinary course of business. As the Company is a reinsurer,
payments are requested in bulk by the Company's ceding insurers, and payment of
reinsurance proceeds would be made in bulk. The Company is not required to make
payment to individual bond obligees. Ultimately, all recovery efforts in the
event of any Year 2000 bug related event can either be handled internally, or
would require the intervention of hardware, software or other technology
vendors. The Company maintains a list of the appropriate contacts at such
vendors in the event such a need arises
32
<PAGE>
PART II - OTHER INFORMATION
Item 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the annual meeting of the Corporation's shareholders held on May 20, 1999,
the ten nominees listed below were elected as directors of the Corporation to
hold office until the 2002 annual meeting and until their successors shall have
been elected and qualified. The number of votes cast for, against or withheld
and the number of abstentions with respect to each such matters is set forth
below, as are the number of broker non-votes, where applicable.
(a) Election of Directors
- ------------------------- --------------------------- --------------------------
Name Votes For Votes Withheld
- ------------------------- --------------------------- --------------------------
Harrison W. Conrad, Jr. 28,201,998 454,485
- ------------------------- --------------------------- --------------------------
Richard L. Huber 28,202,298 454,185
- ------------------------- --------------------------- --------------------------
Jerome F. Jurschak 28,202,198 454,285
- ------------------------- --------------------------- --------------------------
Steven D. Kesler 28,201,798 454,685
- ------------------------- --------------------------- --------------------------
Philip H. Robinson 28,201,547 454,936
- ------------------------- --------------------------- --------------------------
Edwin L. Russell 28,202,298 454,185
- ------------------------- --------------------------- --------------------------
J. Randolph Respess 28,201,698 454,785
- ------------------------- --------------------------- --------------------------
Barbara D. Stewart 28,201,718 454,765
- ------------------------- --------------------------- --------------------------
Jeffrey F. Stuermer 28,201,718 454,765
- ------------------------- --------------------------- --------------------------
Joseph W. Swain 28,202,198 454,285
- ------------------------- --------------------------- --------------------------
33
<PAGE>
Item 5 OTHER INFORMATION
Information Regarding Shareholder Proposals at the 2000 Annual Meeting
In order to present a proposal at the 2000 Annual Meeting of Stockholders, must
provide written notice of the proposal to the Company no later than March 6,
2000. The Company intends to use discretionary voting authority with respect to
any matter that brought before the 2000 annual meeting of stockholders of which
the Company has not received written notice by March 6, 2000.
Capital Re Corporation
1325 Avenue of the Americas
New York, NY 10019
Attn.: Alan S. Roseman
Executive Vice President
General Counsel and Secretary
Item 6 EXHIBITS AND REPORTS ON FORM 8-K
(A) THE FOLLOWING IS ANNEXED AS AN EXHIBIT:
EXHIBIT
NUMBER DESCRIPTION
4 JANUARY 1999 AMMENDMENT TO THE CREDIT AGREEMENT, DATED AS OF JANUARY
22, 1999, AMONG CAPITAL RE CORPORATION, VARIOUS BANKS AND DEUTSCHE
BANK AG, NEW YORK BRANCH, AS AGENT
10 CAPITAL RE CORPORATION RETENTION AGREEMENT EFFECTIVE DECEMBER 21, 1998
BETWEEN CAPITAL RE CORPORATION AND SUSAN HOOKER
11 STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS (UNAUDITED)
(B) REPORTS ON FORM 8-K: NONE
34
<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.
CAPITAL RE CORPORATION
DATE: AUGUST 13, 1999 BY /s/ David A. Buzen
------------------------------
DAVID A. BUZEN
EXECUTIVE VICE PRESIDENT AND
CHIEF FINANCIAL OFFICER
DATE: AUGUST 13, 1999 BY /s/ Alan S. Roseman
------------------------------
ALAN S. ROSEMAN
EXECUTIVE VICE PRESIDENT,
GENERAL COUNSEL AND SECRETARY
35
<PAGE>
INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION PAGE
- ------ ----------- ----
4 JANUARY 1999 AMENDMENT TO THE CREDIT AGREEMENT, DATED AS OF 37-39
JANUARY 22, 1999, AMONG CAPITAL RE CORPORATION, VARIOUS
BANKS AND DEUTSCHE BANK AG, NEW YORK BRANCH, AS AGENT
10 CAPITAL RE CORPORATION RETENTION AGREEMENT EFFECTIVE 40-44
DECEMBER 21, 1998 BETWEEN CAPITAL RE CORPORATION AND SUSAN
HOOKER
11 STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS 45
(UNAUDITED)
36
JANUARY 1999 AMENDMENT TO THE CREDIT AGREEMENT
JANUARY 1999 AMENDMENT TO THE CREDIT AGREEMENT (this "Amendment"), dated as
of January 22, 1999, among Capital Re Corporation (the "Borrower"), various
banks (the "Banks") and Deutsche Bank AG, New York Branch, as agent (the
"Agent"). All capitalized terms defined in the hereinafter defined Credit
Agreement shall have the same meaning when used herein unless otherwise defined
herein.
WITNESSETH:
WHEREAS, the Borrower, the Banks and the Agent entered into a Credit
Agreement, dated as of January 27, 1994 (as amended to date, the "Credit
Agreement");
WHEREAS, pursuant to Section 3.03(b) of the Credit Agreement the
Commitments of KBC Bank N.Y. (formerly known as Kredietbank N.V.) and
Westdeutsche Landesbank Girozentrale, New York Branch, expire on the date
hereof;
WHEREAS, no Loans are presently outstanding under the Credit Agreement;
WHEREAS, after the date hereof Deutsche Bank AG, New York Branch, shall be
the sole Bank;
WHEREAS, the parties hereto wish to amend the Credit Agreement as herein
provided;
NOW, THEREFORE, in consideration of the premises and the mutual covenants
herein contained, the parties hereto hereby agree as follows:
1. Amendments to the Credit Agreement. (a) The first sentence of Section
3.04(a) of the Credit Agreement is hereby amended in its entirety to read as
follows:
The expiration date of the Commitments of the Banks to make Revolving Loans
shall be January 21, 2000 (the "Revolving Loan Expiry Date"); provided,
however, that before (but not earlier than 120 days nor later than 45 days
before) the Revolving Loan Expiry Date then in effect, the Borrower may
make a written request (an "Extension Request") to the Agent at its Notice
Office and each of the Banks that the Revolving Loan Expiry Date be
extended by 364 days.
(b) Schedule I of the Credit Agreement is hereby amended in its entirety to
the form attached hereto as Annex A.
2. Representations and Warranties. In order to induce the Banks and the
Agent to enter into this Amendment, the Borrower hereby represents and warrants
that:
(a) no Default or Event of Default exists or will exist as of the date
hereof and after giving effect to this Amendment; and
37
<PAGE>
(b) as of the date hereof after giving effect to this Amendment, all
representations, warranties and agreements of the Borrower contained in the
Credit Agreement will be true and correct in all material respects.
3. GOVERNING LAW. THIS AMENDMENT AND THE RIGHTS AND OBLIGATIONS OF THE
PARTIES HEREUNDER SHALL BE CONSTRUED IN ACCORDANCE WITH AND BE GOVERNED BY THE
LAW OF THE STATE OF NEW YORK, WITHOUT GIVING EFFECT TO THE CHOICE OF LAW
PROVISIONS THEREOF.
4. Agreement Not Otherwise Amended. This Amendment is limited precisely as
written and shall not be deemed to be an amendment, consent, waiver or
modification of any other term or condition of the Credit Agreement or any of
the instruments or agreements referred to therein, or prejudice any right or
rights which the Banks, the Agent or any of them may now have or may have in the
future under or in connection with the Credit Agreement or any of the
instruments or agreements referred to therein. Except as expressly modified
hereby, the terms and provisions of the Credit Agreement shall continue in full
force and effect. Whenever the Credit Agreement is referred to in the Credit
Agreement or any of the instruments, agreements or other documents or papers
executed and delivered in connection therewith, it shall be deemed to be a
reference to the Credit Agreement as modified hereby.
5. Counterparts. This Amendment may be executed in two or more
counterparts, each of which shall be deemed an original, but all of which
together shall constitute one and the same instrument.
IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be
duly executed and delivered by their respective duly authorized officers as of
the date first above written.
CAPITAL RE CORPORATION
By /s/ David A. Buzen
-------------------------------------
Title: EVP & CFO
DEUTSCHE BANK AG, NEW YORK
BRANCH, Individually and as Agent
By /s/ John S. McGill
----------------------------------
Title: John S. McGill
Vice President
By /s/ Alan Xrouk
----------------------------------
Title: Alan Xrouk
Associate
38
<PAGE>
ANNEX A
SCHEDULE I
SCHEDULE OF COMMITMENTS
Bank Commitment
---- ----------
Deutsche Bank AG, $29,000,000
New York Branch
Total Commitment $29,000,000
===========
39
CAPITAL RE CORPORATION
RETENTION AGREEMENT
This Retention Agreement is effective on the 21st day of December 1998,
between Capital Re Corporation (the "Company"), and Susan Hooker (the
"Executive").
WHEREAS, the Executive, as Executive Vice President and Chief Underwriting
Officer of the Company, is an important part of Company management; and
WHEREAS, the Company desires to assure itself of continuity of management
and the continued availability of the services of Executive and in furtherance
thereof is willing to provide an incentive to the employee to remain with the
Company; and
WHEREAS, the Executive is willing to remain with the Company under the
terms and conditions provided herein;
NOW, THEREFORE, in consideration of these premises and other good and
valuable consideration, the Company and Executive agree as follows:
1. Term. This Agreement shall terminate on January 31, 2000 (the
"Termination Date").
2. Retention Payment and Stock Appreciation Payment. The Executive will
receive a payment of $150,000 on January 3, 2000 (the "Retention Payment") if,
in the good faith judgment of the Compensation Committee of the Board of
Directors of the Company (a) the Company has maintained key Capital Re group
ratings in categories that do not result in a material impairment of the
business and (b) the 1999 Capital Plan approved by the Board of Directors has
been successfully executed; provided, however, that, except as otherwise
provided in Section 3.1, the Executive remains employed by the Company through
December 31, 1999. In addition, on or prior to January 31, 2000, the Executive
shall receive from the Company in cash an amount equal to the difference between
the fair market value of a share of Company common stock on January 15, 2000 and
$19.25 multiplied by 23,333 (the "Stock Appreciation Payment"), provided,
however, that, except as otherwise provided in Section 3.1, the Executive
remains employed by the Company through December 31, 1999.
3. Termination of Employment and Severance
3.1 Termination by the Company; Termination by the Executive for Good
Reason. If for any reasons other than for Cause (as
40
<PAGE>
Retention Agreement
Page 2 of 5 Pages
hereafter defined), or death or disability, the Company terminates the
Executive's employment during the Term or the Executive terminates employment
for Good Reason, the Company shall pay Executive, as liquidated damages or
severance pay or both, a lump sum amount equal to the Retention Payment and the
Stock Appreciation Payment. For purposes of this Agreement, "Good Reason" shall
mean (a) the Company's material breach of this Agreement or any other material
agreement between the Executive and the Company, or (b) the assignment to the
Executive of any duties substantially inconsistent with the Executive's status
as Executive Vice President and Chief Underwriting Officer of the Company or a
substantial adverse alteration in the nature or status of the Executive's
responsibilities.
3.2 Termination Due to Death, Disability or Cause. If the Executive's
employment is terminated prior to December 31, 1999 for Cause, there shall be no
Retention Payment or Stock Appreciation Payment. If the Executive's employment
is terminated prior to December 31, 1999 due to death or disability, the Company
shall pay Executive, as liquidated damages or severance pay or both, a lump sum
amount equal to the Stock Appreciation Payment but not the Retention Payment.
For the purposes of this Agreement, Cause shall mean (i) gross negligence or
willful misconduct in connection with the performance of duties; (ii) conviction
of a criminal offense (other than minor traffic offenses); or (iii) material
breach of any term of any employment, consulting or other services,
confidentiality, intellectual property or non-competition agreements, if any,
between Executive and the Company or any of its affiliates.
3.3 Voluntary Termination by the Executive. If the Executive voluntarily
terminates her employment for any reason, other than Good Reason, prior to
December 31, 1999, there shall be no Retention Payment or Stock Appreciation
Payment.
4. Withholding of Taxes. The Company shall have the right to deduct from
payments of any kind otherwise due to the Executive any federal, state, or local
taxes of any kind required by law to be withheld with respect to any payments
under this Agreement.
5. Successors; Binding Agreement. The Company will require any successor
(whether direct or indirect, by purchase, merger, consolidation or otherwise) to
all or substantially all of the business and/or assets of the Company to
expressly assume and agree to perform this Agreement in the same manner and to
the same extent that the Company would be required to perform it if no such
succession had taken place. Failure of the Company to obtain such assumption and
agreement prior to the effectiveness of any such succession shall be a breach of
this Agreement and shall entitle the Executive to compensation from the Company
in
41
<PAGE>
Retention Agreement
Page 3 of 5 Pages
the same amount and on the same terms as she would be entitled to hereunder if
she terminated her employment for Good Reason, except that for purposes of
implementing the foregoing, the date on which any such succession becomes
effective shall be deemed the Date of Termination. As used in this Agreement,
"Company" shall mean the Company as herein before defined and any successor to
its business and/or assets as aforesaid which executes and delivers the
agreement provided for in this Section 5 or which otherwise becomes bound by all
the terms and provisions of this Agreement by operation of law.
This Agreement and all rights of the Executive hereunder shall inure to the
benefit of and be enforceable by the Executive's personal or legal
representatives, executors, administrators, successors, heirs, distributees,
devisees and legatees. If the Executive should die while any amounts would still
be payable to her hereunder if she had continued to live, all such amounts,
unless otherwise provided herein, shall be paid in accordance with the terms of
this Agreement to the Executive's devisee, legatee, or other designee or, if
there be no such designee, to the Executive's estate.
6. Notice. For the purposes of this Agreement, notices, demands and all
other communications provided for in this Agreement shall be in writing and
shall be deemed to have been duly given when delivered or (unless otherwise
specified) sent by United States certified or registered mail or overnight
delivery service, addressed as follows:
If to the Executive:
Susan Hooker
c/o Capital Re Corporation
1325 Avenue of the Americas
New York, New York 10019
If to the Company:
Capital Re Corporation
1325 Avenue of the Americas
New York, New York 10019
Attention: General Counsel
or to such other address as any party may have furnished to the others in
writing in accordance herewith, except that notices of change of address shall
be effective only upon receipt.
42
<PAGE>
Retention Agreement
Page 4 of 5 Pages
7. Miscellaneous. No provisions of this Agreement may be modified, waived
or discharged unless such waiver, modification or discharge is agreed to in
writing signed by the Executive and the Company. No waiver by either party
hereto at any time of any breach by the other party hereto of, or compliance
with, any condition or provision of this Agreement to be performed by such other
party shall be deemed a waiver of similar or dissimilar provisions or conditions
at the same or at any prior or subsequent time. No agreements or
representations, oral or otherwise, express or implied, with respect to the
subject matter hereof have been made by either party which are not set forth
expressly in this Agreement. The validity, interpretation, construction and
performance of this Agreement shall be governed by the laws of the State of New
York without regard to its conflicts of law principles.
8. Validity. The invalidity or unenforceability of any provision or
provisions of this Agreement shall not affect the validity or enforceability of
any other provision of this Agreement, which shall remain in full force and
effect.
9. Counterparts. This Agreement may be executed in one or more
counterparts, each of which shall deemed to be in an original but all of which
together will constitute one and the same instrument.
10. Resolution of Disputes. Any claim arising out of or relating to this
Agreement or the Executive's employment with the Company or the termination
thereof shall be resolved by binding confidential arbitration, to be held in New
York, New York, in accordance with the Commercial Arbitration Rules of the
American Arbitration Association. Judgment upon the award rendered by the
arbitrator(s) may be entered in any court having jurisdiction thereof.
11. Entire Agreement. This Agreement sets forth the entire agreement of the
parties hereto in respect of the subject matter contained herein and supersedes
all prior agreements, promises, covenants, arrangements, communications,
representations or warranties, whether oral or written, by any officer, employee
or representative of any party hereto; and any prior agreement of the parties
hereto in respect of the subject matter contained herein shall, with respect to
the Executive, be of no further force and effect.
43
<PAGE>
Retention Agreement
Page 5 of 5 Pages
IN WITNESS WHEREOF, the parties have executed this Agreement on the date
and year first above written.
CAPITAL RE CORPORATION
Attest:
By: By:
----------------------------- --------------------------------
Name:
Title:
EXECUTIVE:
Attest:
By: By:
----------------------------- --------------------------------
Title:
44
CAPITAL RE CORPORATION AND SUBSIDIARIES
Exhibit 11 Statement Re: Computation of Per Share Earnings
(Dollars in thousands except per share amounts)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
--------------------- ---------------------
1999 1998 1999 1998
--------------------- ---------------------
<S> <C> <C> <C> <C>
Net Income from Continuing Operations (89,592) 19,683 (70,214) 39,958
Net Income (106,814) 20,186 (93,879) 39,981
Basic weighted average shares outstanding during the period 32,795 31,865 32,404 31,849
Potentially dilutive employee stock options 355 1160 344 1102
--------------------- ---------------------
Diluted weighted average shares outstanding during the period 33,150 33,025 32,748 32,951
===================== =====================
Basic earnings per common share from continuing operations ($2.73) $ 0.62 ($2.17) $ 1.25
===================== =====================
Diluted earnings per common share from continuing operations ($2.70) $ 0.60 ($2.14) $ 1.21
===================== =====================
Basic earnings per common share ($3.26) $ 0.63 ($2.90) $ 1.26
===================== =====================
Diluted earnings per common share ($3.22) $ 0.61 ($2.87) $ 1.21
===================== =====================
</TABLE>
45
<TABLE> <S> <C>
<ARTICLE> 7
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> JUN-30-1999
<DEBT-HELD-FOR-SALE> 1,235,048
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 0
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 1,235,048
<CASH> 14,082
<RECOVER-REINSURE> 3,468
<DEFERRED-ACQUISITION> 149,561
<TOTAL-ASSETS> 1,530,648
<POLICY-LOSSES> 142,601
<UNEARNED-PREMIUMS> 425,238
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 99,875
75,000
0
<COMMON> 369
<OTHER-SE> 554,399
<TOTAL-LIABILITY-AND-EQUITY> 1,530,648
106,274
<INVESTMENT-INCOME> 34,849
<INVESTMENT-GAINS> 5,028
<OTHER-INCOME> 3,174
<BENEFITS> 187,927
<UNDERWRITING-AMORTIZATION> 27,064
<UNDERWRITING-OTHER> 7,228
<INCOME-PRETAX> (111,870)
<INCOME-TAX> (41,656)
<INCOME-CONTINUING> (70,214)
<DISCONTINUED> (23,665)
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (93,879)
<EPS-BASIC> (2.90)
<EPS-DILUTED> (2.87)
<RESERVE-OPEN> 84,553
<PROVISION-CURRENT> 50,172
<PROVISION-PRIOR> 57,891
<PAYMENTS-CURRENT> 56
<PAYMENTS-PRIOR> 52,808
<RESERVE-CLOSE> 139,752
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
