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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
COMMISSION FILE NUMBER 1-10804
XL CAPITAL LTD
(Exact name of registrant as specified in its charter)
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CAYMAN ISLANDS 98-0058718
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
CUMBERLAND HOUSE, 1 VICTORIA STREET,
HAMILTON, BERMUDA HM 11
(Address of principal executive offices) (Zip Code)
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(441) 292-8515
(Registrant's telephone number, including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
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TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
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Class A Ordinary Shares, New York Stock Exchange, Inc.
Par Value $0.01 per Share
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. / /
The aggregate market value of the shares of all classes of voting stock of
the registrant held by non-affiliates of the registrant on November 26, 1999 was
approximately $6.7 billion computed upon the basis of the closing sales price of
the Ordinary Shares on that date. For purposes of this computation, shares held
by directors and officers of the registrant have been excluded. Such exclusion
is not intended, nor shall it be deemed, to be an admission that such persons
are affiliates of the registrant.
As of November 26, 1999 there were outstanding 124,543,920 Class A Ordinary
Shares, $0.01 par value per share, and 3,115,900 Class B Ordinary Shares, $0.01
par value per share, of the registrant.
DOCUMENTS INCORPORATED BY REFERENCE
THE REGISTRANT'S DEFINITIVE PROXY STATEMENT FILED WITH THE SECURITIES AND
EXCHANGE COMMISSION PURSUANT TO REGULATION 14A RELATING TO THE ANNUAL MEETING OF
SHAREHOLDERS HELD ON APRIL 9, 1999 IS INCORPORATED BY REFERENCE IN PART III OF
THIS FORM 10-K.
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XL CAPITAL LTD
TABLE OF CONTENTS
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PART I
Item 1. Business.................................................... 1
Item 2. Properties.................................................. 19
Item 3. Legal Proceedings........................................... 19
Item 4. Submission of Matters to a Vote of Security Holders......... 19
PART II
Item 5. Market for the Registrant's Common Stock and Related
Stockholder Matters......................................... 22
Item 6. Selected Financial Data..................................... 24
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 25
Item 8. Financial Statements and Supplementary Data................. 36
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 80
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 80
Item 11. Executive Compensation...................................... 80
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 80
Item 13. Certain Relationships and Related Transactions.............. 80
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form
8-K......................................................... 80
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THIS ANNUAL REPORT ON FORM 10-K CONTAINS "FORWARD-LOOKING STATEMENTS" AS
DEFINED IN THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. A NON-EXCLUSIVE
LIST OF THE IMPORTANT FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER
MATERIALLY FROM THOSE IN SUCH FORWARD LOOKING STATEMENTS IS SET FORTH HEREIN
UNDER THE CAPTION "MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION--CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS.
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PART I
ITEM 1. BUSINESS
RECENT DEVELOPMENTS
On June 18, 1999, XL Capital Ltd ("XL" or the "Company") completed its
merger with NAC Re Corp., a Delaware Corporation ("NAC Re"), in a stock merger.
Shareholders of NAC Re received 0.915 Company share for each NAC Re share in a
tax free exchange. Approximately 16.9 million of the Company's Class A ordinary
shares were issued in this transaction. NAC Re has reinsurance and insurance
subsidiaries in the United States and the United Kingdom.
The NAC Re merger was accounted for as a pooling of interests under U.S
generally accepted accounting principles ("U.S GAAP"). Accordingly, all prior
period information contained in this document includes the results of NAC Re as
though it had always been a part of the Company. Following the merger, the
Company changed its fiscal year end from November 30(th) to December 31(st) as a
conforming pooling adjustment. Consolidated financial information presented
herein is based upon the new fiscal year end.
HISTORY
The Company was incorporated with limited liability under the Cayman Islands
Companies Act on March 16, 1998, as EXEL Merger Company. As discussed below, the
Company was formed as a result of the merger of EXEL Limited ("EXEL") and Mid
Ocean Limited ("Mid Ocean" or "MOL") on August 7, 1998, and was renamed EXEL
Limited on that date. EXEL and Mid Ocean are companies that were incorporated in
the Cayman Islands in 1986 and 1992, respectively. At a special general meeting
held on February 1, 1999, the shareholders of the Company approved a resolution
changing its name to XL Capital Ltd. The Company, through its subsidiaries, is a
leading provider of insurance and reinsurance coverages and financial products
to industrial, commercial, and professional service firms, insurance companies
and other enterprises on a worldwide basis.
NAC Re was organized in 1985 for the purpose of holding all the outstanding
shares of NAC Reinsurance Corporation ("NAC"), a property and casualty
reinsurance company. NAC is licensed to write reinsurance in all 50 states, the
District of Columbia, Puerto Rico and all provinces of Canada. NAC has a
subsidiary, NAC Reinsurance International Limited ("NAC Re International"),
based in London. NAC Re International has a branch in Sydney, Australia and a
contact office in Madrid, Spain. NAC also owns Greenwich Insurance Company
"Greenwich", a California domiciled insurance company licensed in all 50 states
to write primary insurance and reinsurance, Indian Harbor Insurance Company
("Indian Harbor"), a North Dakota domiciled insurance company that writes
primary business as a surplus lines carrier in selected states, and Denham
Syndicate Management Limited ("Denham"), a Lloyd's Managing agency that manages
Denham Syndicate 990.
At a class meeting held on August 3, 1998, the shareholders of EXEL approved
a Scheme of Arrangement (the "EXEL Arrangement") pursuant to section 85 of the
Companies Law (1995 Revision) of the Cayman Islands under which EXEL became a
wholly owned subsidiary of the Company. At separate class meetings held on the
same date, the shareholders of Mid Ocean approved a similar Scheme of
Arrangement (the "Mid Ocean Arrangement" and, together with the EXEL
Arrangement, the "Arrangements") pursuant to section 85 of the Companies Law
(1995 Revision) of the Cayman Islands under which Mid Ocean became a wholly
owned subsidiary of the Company. On August 7, 1998, the Grand Court of the
Cayman Islands approved the Arrangements. EXEL's primary operating subsidiaries
prior to the Arrangements were XL Insurance Ltd ("XLI"), a Bermuda insurance
company, XL Global Reinsurance Company, Ltd. ("XLGRe"), a Bermuda reinsurance
company, and XL Europe Insurance ("XLE"), an Irish insurance company. The two
main operating subsidiaries of Mid Ocean acquired through the merger were Mid
Ocean Reinsurance Company Ltd and The Brockbank Group plc ("Brockbank").
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In November 1998, the Company entered into a joint venture (the "FSA Joint
Venture") with Financial Security Assurance Holdings Ltd., a New York
corporation ("FSA"), to write certain types of financial guaranty insurance and
reinsurance. FSA, through its subsidiaries, is primarily engaged in the business
of providing financial guaranty insurance on asset-backed and municipal
obligations. Under the terms of the joint venture, each of the Company and FSA
formed a Bermuda insurance company in which it is the majority shareholder and
made a minority investment in the company formed by its co-venturer. The Company
formed and maintains majority ownership of XL Financial Assurance Ltd ("XLFA").
FSA formed and maintains majority ownership of Financial Security Assurance
International Ltd. ("FSAI"). Each of XLFA and FSAI has a capitalization of
approximately $100 million. As part of the joint venture, the Company and FSA
exchanged approximately $80 million of each other's stock, following which the
Company owned approximately 6% of the issued and outstanding common stock of
FSA.
On December 2, 1998, the Company announced its intentions to further expand
into the United States by signing a definitive agreement to acquire all of the
outstanding shares of Intercargo Corporation ("Intercargo"). Intercargo, through
its subsidiaries underwrites specialty insurance products for companies engaged
in international trade, including U.S. Customs bonds and marine cargo insurance.
This transaction was completed in June 1999.
In June 1998, the Company formed Reeve Court Insurance Ltd., an insurance
company organized under the laws of Bermuda ("Reeve Court"), as a joint venture
with that company's management for the purpose of providing life insurance to
high net worth individuals.
In March 1998, the Company purchased all of the outstanding shares of
Folksamerica General Insurance Company ("Folksamerica"), a New York corporation.
Upon completion of this transaction, the company was renamed X.L. Insurance
Company of America, Inc. ("XLIA"). The Company's operations in the United States
expanded with the incorporation of XL Risk Solutions, Inc., a Connecticut
insurance company ("XLRS"), in October of 1998. Both entities are capitalized
with $100 million.
The Company acquired GCR Holdings Limited, a Cayman Islands company, in June
1997. The net assets of this company's wholly owned operating subsidiary, Global
Capital Reinsurance Company Limited ("GCR") were combined with XL's reinsurance
operations to form XLGRe. Subsequently, in August of 1998, XLGRe was amalgamated
with Mid Ocean Reinsurance Company Ltd., a subsidiary of Mid Ocean, to form XL
Mid Ocean Reinsurance Ltd ("XLMORe").
In October 1997, the Company and another company formed Latin American
Reinsurance Company, Ltd. ("LARe") under the laws of Bermuda. LARe was
capitalized with $100 million, of which the Company and RCRe contributed
approximately 75% and 25% respectively. LARe is a subsidiary of XLMORe.
In 1996, the Company acquired approximately 28% of Pareto Partners
("Pareto"), a firm which specializes in foreign currency overlay management and
related services. At December 31, 1998, Pareto had approximately $26 billion of
assets under management. The Company works closely with Pareto to develop new
products and ventures, including the F/XL(SM) foreign currency protection
currency protection product offered by XLI.
Unless the context otherwise requires, references herein to "XL" or "the
Company" include subsidiaries of the Company, and references herein to "NAC Re"
or "NAC" shall include their subsidiaries.
OPERATIONS
The Company is organized into three operating segments--insurance,
reinsurance and Lloyd's Syndicates--and a corporate segment, which includes the
investment operations of the Company. The descriptions of policies and coverages
which follow are summary in nature. The terms and conditions of individual
policies or contracts govern, and nothing set forth herein constitutes an
admission of coverage or other liability or an interpretation as to how any
particular policy provision should be interpreted.
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INSURANCE OPERATIONS
The Company, through its subsidiaries, provides both excess and primary
insurance globally through the following subsidiaries: XLI, XLE, XLIA, XLRS,
Greenwich and Indian Harbor.
The Company, through XLI and XLE, provides third party general liability
insurance, directors and officers liability insurance, professional liability
insurance, employment practices liability insurance and integrated liability
insurance, property insurance and other insurance covers (including political
risk insurance and financial products). The liability insurance is written on an
excess basis and the loss experience generally is characterized as low frequency
and high severity. Property insurance is written on a pro rata as well as an
excess basis. Policies written on a pro rata basis can have losses attaching at
lower levels resulting in loss experiences that can be higher frequency and
lower severity. The Company generally requires that disputes arising under such
policies be settled by arbitration in London.
General liability policies cover occurrences causing unexpected and
unintended personal injury or property damage (as well as advertising liability)
to third parties arising from events or conditions which commence at or
subsequent to an inception date (or retroactive date, if applicable, but not
prior to January 1, 1986) and prior to the expiration of the policy, provided
proper notice is given during the term of the policy or the discovery period.
Coverage is provided on an occurrence-reported policy form up to a maximum of
$200 million per occurrence with an annual aggregate in excess of a minimum
attachment point of $15 million per occurrence.
Directors and officers coverage is written on a claims-made basis providing
up to a maximum of $25 million in excess of $20 million for United States risks
and up to $50 million for individual director indemnification and excluding
corporate reimbursement in excess of $20 million, or $15 million in excess of
$15 million for non-United States risks, or a limit of $25 million in excess of
not less than $25 million. A policy generally adopts the terms, conditions and
exclusions in the primary or other underlying policy.
Professional liability risks are written either on a follow-form basis
(i.e., the policy generally adopts the terms, conditions and exclusions of the
underlying policy, which usually is a "claims-made" policy) or on a form which
is structured similarly to the general liability form in that it is extended
from year to year (with annual underwriting reviews). Coverage is provided for
certain categories of risk up to a maximum of $50 million with a minimum
attachment of $25 million, or $20 million for law firms.
Employment practices liability risks are written on a claims-made and
reported policy. The policy is written on an annual basis and covers claims
brought by an employee against an insured for certain covered employment
practices.
The Company, through a coordinated initiative with subsidiaries of CIGNA
Corporation ("CIGNA"), offers multi-year, combined line coverages for
traditional casualty coverages, including general, directors and officers and
professional liability, and property coverage plus blended finite coverage for
risks which traditionally have had difficulty placing cover. The target market
is large and medium size companies that are trying to simplify and streamline
the risk transfer process. CIGNA provides services and fronting policies to meet
U.S. regulatory requirements and provides an excess policy for the balance of
capacity and coverages required. Available capacity by line of coverage is
$60 million to $200 million depending upon the lines selected. Attachment levels
may in certain situations be provided below levels that the Company normally
requires, subject to the underwriting requirements. The programs are typically
custom designed to meet specific needs with each customer.
The Company's insurance operations underwrite property risks primarily on an
excess of loss occurrence and pro rata form (except earthquake and flood when
provided) utilizing engineering reports, statement of values, prior loss
history, annual report and other publicly available information. Earthquake and
flood coverage are written on an excess of loss attachment basis which may be
eroded in a given policy year by accumulated losses from separate occurrences as
customary in the industry. When written as such, earthquake and flood insurance
have annual aggregate limits. All classes of business are considered. The
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minimum attachment points are generally $25 million for industrial and
commercial accounts and $100 million for oil and petrochemical accounts.
Industrial and commercial accounts will also be written on a pro rata basis with
attachments as low as $1 million.
The Company writes primary program insurance in the United States through
Greenwich and Indian Harbor. The principal lines of primary business written
include certain specialty classes such as auto warranty business. The business
is written principally through managing general agents and general agents. The
Company evaluates each business relationship based upon the underwriting
experience and operational expertise of each distribution channel selected, and
performs an analysis to evaluate financial security. The Company periodically
performs underwriting, claims and operational audits of each pool and agency
relationship.
Insurance is also provided to cover political risk and financial risk.
Political risk insurance coverage, including expropriation, currency
inconvertibility and certain other types of political risk associated with
cross-border investment, is provided through the Company's 40.5% interest in
Sovereign Risk Insurance Ltd. ("Sovereign"), a Bermuda based managing general
agency. Policies written by Sovereign are subscribed 50% by each of XL and
Sovereign's other insurance company shareholder and RCRe participating in up to
10% of each risk written on a quota share reinsurance basis. Sovereign's
per-country aggregate limit is $100 million, except with respect to Argentina,
Brazil, China and Indonesia which have an aggregate limit of $250 million each,
and its per risk limit is $50 million.
The Company, through XLI, also offers insurance and reinsurance solutions
for certain types of financial risks. XLI sells customized basket, and in
certain circumstances, single-currency options for the purpose of mitigating
exposures which corporate and financial institution customers have to selected
major currencies. XLI engages Pareto as an advisor to assist in the evaluation
of particular foreign currency protection contracts and to manage risks
associated with such transactions. Options have a duration of up to one year.
Unrealized gains and losses are marked-to-market on a periodic basis and
reflected quarterly in the Company's consolidated statements of income. At
fiscal year-end 1998, XLI had written options having an aggregate nominal value
of $200 million, with no single option accounting for more than $100 million.
Using its proprietary foreign currency overlay management technology, Pareto
attempts to manage XLI's risk of loss so that it will generally not exceed 3% of
the nominal amount of each option under the vast majority of possible scenarios.
Gains from Pareto's management activities are also possible. Although XLI
believes that Pareto will generally manage at or above the 3% loss floor and may
produce gains on some contracts, actual losses and gains may be greater or less,
respectively, than anticipated due to a variety of factors, including, without
limitation, flaws in Pareto's highly quantitative, model-driven technology, the
inability to execute hedging and other transactions called for by Pareto's
technology in a timely or cost efficient manner, especially in periods of
significant market volatility or illiquidity, and to uncertainties surrounding
the application of Pareto's technology, which is predicted on a basket option
approach, to a single-currency or other non-basket option types of transactions.
See "Management's Discussion and Analysis of Results of Operations and Financial
Condition--Cautionary Note Regarding Forward-Looking Statements" for a list of
factors which could cause actual results to differ materially from those
contained in any forward-looking statement.
XLI and XLFA provide financial guaranty insurance and reinsurance in respect
of asset-backed, future flow and municipal obligations. Financial guaranty
policies generally cover non-payment of principal and interest when due.
Particular types of transactions which XLI and XLFA have underwritten or
considered underwriting include financial guaranty insurance and reinsurance in
respect of bonds issued by public utilities, collateralized bond and
collateralized loan obligations, mortgage-backed securities, certain low income
housing tax credits, prime and sub-prime automobile loans, credit default swaps,
project finance-related obligations and other types of structured insurance and
reinsurance risks, including residual value insurance for certain asset classes.
The underlying risks guaranteed include both OECD (Organization for Economic
Cooperation and Development) and emerging market issuers and assets. Guarantees
provided by XLI and XLFA relate generally, but not exclusively, to investment
grade
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obligations. Gross and net retentions in respect of financial guaranty and
related risks are determined by XLI and XLFA on a case-by-case basis in light of
the particular credit, actuarial, structuring and other risks associated with
each transaction. Exposure to a financial guaranty or related risk can exceed
$100 million. XLI and XLFA also may provide financial guaranty "fronting"
services in return for fees and other revenues on behalf of insurers or
reinsurers whose claims paying ratings are below their own. The fronting party
is generally required to pay the full amount of any claim even if it cannot
recover all or part of the balance due from an insurer or reinsurer for which
the service was provided.
REINSURANCE OPERATIONS
The Company, through NAC and XLMORe, provides a broad range of reinsurance
products on a global basis. Business is written on both a proportional and
excess of loss basis.
XLMORe's business is primarily short-tail in nature and includes property
catastrophe, property excess of loss, property pro rata, marine and energy,
aviation and satellite and various other reinsurance to insurers on a worldwide
basis. A significant portion of XLMORe's business underwritten consists of large
aggregate exposures to man-made and natural disasters and generally loss
experience is characterized as low frequency and high severity. This may result
in volatility in the Company's financial results. The Company endeavors to
manage its exposures to catastrophic events by limiting the amount of its
exposure in each geographic zone worldwide and requiring that its property
catastrophe contracts provide for aggregate limits and varying attachment
points.
NAC is principally engaged in providing treaty and facultative reinsurance
to primary insurers of casualty risks (principally general liability,
professional liability, automobile and workers' compensation) and commercial and
personal property risks and specialty risks (including fidelity/surety and ocean
marine). A significant portion of NAC's business in 1998 was written on an
excess of loss basis, under which the Company indemnifies an insurer for a
portion of the losses on insurance policies in excess of a specified loss
amount, generally $1 million or more, and up to an amount per loss specified in
the contract. The balance of NAC's business is written on a pro rata basis under
which NAC assumes from the primary insurer a percentage of loss specified in the
treaty of each risk in the reinsured class.
The Company's property catastrophe reinsurance account is generally "all
risk" in nature. It is therefore exposed to losses from sources as diverse as
windstorms, earthquakes, freezes, riots, floods, industrial explosions, fires or
any number of other potential disasters. In accordance with market practice, the
Company's policies generally exclude certain risks such as war, nuclear
contamination or radiation. The Company's predominant exposure under such
coverage is to property damage. However, other risks, including business
interruption, death and injury under workers compensation policies and other
non-property losses may also be covered under a property reinsurance contract
when arising from a covered peril. Property catastrophe reinsurance provides
coverage on an excess of loss basis when aggregate losses and loss adjustment
expenses from a single occurrence of a covered peril exceed the attachment point
specified in the policy. Some of the Company's property catastrophe contracts
limit coverage to one occurrence in any one policy year, but most contracts
generally provide for one reinstatement.
The company also writes property risk excess of loss reinsurance. Risk
excess of loss reinsurance responds to a loss of the reinsured on a single
"risk" of the type reinsured rather than to aggregate losses for all covered
risks as does catastrophe reinsurance. The risk excess of loss policy protects
the reinsured from losses in excess of its retention level on a single risk. A
"risk" in this context might mean the insurance coverage on one building or a
group of buildings or the insurance coverage under a single policy, which the
reinsured treats as a single risk. Risk excess contracts are generally "all
risk" in nature, as previously described.
The Company's property pro rata account includes proportional reinsurance of
direct written property insurance. The Company considers this business to be
related to its catastrophe and other property
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exposures. In proportional reinsurance, the Company assumes a specified
proportion of the risk on the specified coverage and receives an equal
proportion of the premium. The ceding insurer receives a commission, based upon
the premiums ceded to the Company, and the ceding insurer may also be entitled
to receive a profit commission based upon the ratio of losses, loss adjustment
expense and the Company's expenses to premium ceded. The Company is dependent
upon the ceding insurer's underwriting, pricing and claims administration to
yield an underwriting profit. In some instances, the Company may be entitled to
the benefit of other reinsurance, known as common account reinsurance, purchased
by the ceding company on an account reinsured by the Company on a proportional
basis.
The aviation portfolio comprises both direct insurance and reinsurance, on
both a proportional and excess of loss basis. The exposures are mainly derived
through proportional relationships on defined segments of account following
market leaders in the field. Due to the highly technical nature of the satellite
business, the exposures retained by XLMORe under this portfolio are acquired
mostly through proportional reinsurances of specialist underwriters.
The Company provides multi-line reinsurance to the Latin American market,
emphasizing short-tail, multi-peril property reinsurance and, to a limited
extent, casualty, marine, aviation and other lines of reinsurance.
Other reinsurance written by the Company includes political risk, nuclear
accident and professional indemnity.
LLOYD'S OPERATIONS
The Company's Lloyd's operations are conducted by Brockbank and Denham.
Brockbank is a Lloyd's managing general agency, which manages five syndicates,
two of which are dedicated corporate syndicates whose capital is provided solely
by the Company. These corporate syndicates (syndicates 1209 and 2253) write
property, marine and energy, aviation and satellite, motor, professional
indemnity and other specialty lines, primarily of insurance but also
reinsurance, in parallel with the other syndicates (syndicates 588, 861 and 253)
managed by Brockbank. Denham is a Lloyd's managing agency which manages one
Lloyd's syndicate, which is a dedicated corporate syndicate whose capital is
provided solely by the Company and which writes casualty and non-marine physical
damage insurance. As managing agencies, Brockbank and Denham receive fees and
commissions in respect of the underwriting services they provide to syndicates.
Corporate syndicate 1209 writes a wide range of classes across the property,
casualty and marine, aviation and transport sectors to a globally diverse group
of clients. Coverages range from global "all risks" programs for multinationals
to tailored facilities for agents with small and medium sized businesses, with
particular emphasis on North America and Europe. The syndicate's specie account
includes fine art, cash in transit, financial institutions and jewelry. The
syndicate's accident & health account is worldwide and comprises direct personal
accident insurance, personal accident reinsurance, medical expenses and kidnap
and ransom. The professional indemnity account includes E&O, D&O and fidelity,
with particular emphasis in the service sectors (financial institutions,
lawyers, information technology, architects and engineers) in North America. The
syndicate offers extended warranty on all forms of electrical and mechanical
equipment, plant and motor vehicles, as well as the full range of the
traditional engineering covers. The bloodstock account covers high value
thoroughbred horses across the world, with a particularly strong presence in the
United Kingdom, Ireland, United States, Japan and Australasia. Cover is also
provided for pets, fish farms and exotic animals.
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Through the marine, hull and machinery account, syndicate 1209 has a
significant involvement with many of the word's largest fleets. The syndicate's
energy account comprises cover for all elements of the worldwide hydrocarbon
industry. The main focus has been on the established production areas, but
opportunities in developing markets are actively pursued. The syndicate writes a
space account and is involved at every stage of major space launches and
associated pre-launch operations. The marine liability account embraces all the
major types of cover available, including pollution insurance, financiers'
exposures and certificates of financial responsibility reinsurance, as well as
the more traditional wet liability cover, such as charterers' liabilities. The
syndicate writes a broad international cargo account, specializing in the
technology sector and in large plant and project equipment. The syndicate also
writes war and political risk cover for ships and aircraft, and also covers most
political risks, including expropriation, confiscation, terrorism and trade
disruption.
Syndicate 1209's treaty reinsurance account provides high excess or
catastrophe coverage predominantly for direct insurers. This account is diverse
and consists of protections for companies ranging from large worldwide
multi-line insurers to the small domestic industrial mutual insurers. Excess of
loss coverage is provided for most lines of insurance.
Syndicate 2253 writes an account of direct and broker based motor insurance
in the United Kingdom, an account which is also written by syndicate 1209.
Brockbank provides motor insurance in the United Kingdom through two
distribution channels: Admiral Insurance Services Limited ("Admiral"), a direct
response motor operation, and Zenith Insurance Policies ("Zenith"), which offers
motor insurance through a network of retail brokers. Admiral concentrates on the
private car market. Zenith operates across a broader range of market segments,
covering areas such as taxis, motorcycles, agricultural vehicles and commercial
fleets, as well as private cars.
In the fourth quarter of 1999, Brockbank sold its two motor insurance
businesses, Admiral and Zenith. The Company expects there to be decreases in
premiums, fee income and certain costs. The Company does not expect the overall
profitability of its Lloyd's operations to be materially affected by such sales.
REINSURANCE CEDED
In many cases, the risks assumed by the Company are reinsured with other
reinsurers. The benefits of ceding risks to other reinsurers reducing exposure
on individual risks, protecting against catastrophic risks and maintaining
acceptable capital ratios. Reinsurance ceded does not legally discharge the
reinsured from its liabilities in respect of the risk being reinsured. The
following is a discussion of the types of reinsurance ceded by the Company.
INSURANCE OPERATIONS
Effective December 1, 1996, XLI and XLE entered into a quota share
reinsurance policy with five U.S. reinsurers and one non-U.S. reinsurer covering
general liability risks only. Effective fiscal 1998, three additional U.S.
reinsurers were added to this program, of which one is Risk Capital Reinsurance
Company ("RCRe"), a Nebraska corporation in which the Company has an indirect
28% ownership interest. Under the terms of the policy, XLI cedes 20% of risks
with total limits up to $100 million and 25% of risks with total limits in
excess of $100 million up to $150 million. Effective December 1, 1998, 20% of
all general liability business is ceded up to a limit of $150 million. The
maximum amount recoverable from the reinsurers will be the ceded percentage of
the original policy limit on a per occurrence basis, with an annual aggregate of
225% of the total premium ceded. No single reinsurer participates in excess of
20% of the quota share. With the exception of RCRe, all of the reinsurers are
rated, of which the lowest as rated by Standard & Poor's Corporation ("S&P") is
BBB. The most significant reinsurers on this program are Fireman's Fund,
Hannover Re and Hartford Re. These companies are rated A, AA+ and AA+ by S&P,
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respectively, with participations of 16.0%, 18.67% and 16.0%, respectively, on a
reinsurance balance receivable of $176.9 million.
Effective September 1, 1997, XLI and XLE entered into an excess of loss
casualty catastrophe contract covering all general liability risks. Under the
terms of this policy, XLI and XLE are reinsured for $80 million ultimate net
loss each occurrence excess of a per occurrence retention, subject to an annual
aggregate retention. The maximum amount recoverable from the reinsurers will be
an annual aggregate of $250 million. This policy was extended to November 30,
1998 and renewed December 1, 1998, with 97.75% of this reinsurance being placed
with seventeen reinsurers, all of which are rated. With the exception of two
reinsurers, the lowest as rated by S&P is A-. The other two reinsurers are rated
BBB and BB by S&P, representing a participation of less than 4% on this program.
Property quota share reinsurance of 25% (subject to catastrophe occurrence
limit restrictions) of XLI's property policy limit is purchased from two
Bermuda-based property reinsurers, four U.S. reinsurers and one non-U.S.
reinsurer. All property reinsurers are rated with a minimum S&P rating of A-.
XLI reinsures one third of the first $75 million in limits of employment
practices liability to an U.S. insurer and the remaining excess layer of
$25 million to a Bermuda-based insurer.
A quota share arrangement exists between XLI and CIGNA based on pre-agreed
percentages by line of coverage for blended covers written through XL Risk
Solutions and CIGNA Risk Solutions. These percentages vary from 12.5% to 90%,
but do not exceed XL's normal capacity on individual lines of cover. XLI may
underwrite an account 100% without CIGNA participation.
REINSURANCE OPERATIONS
Traditionally, XLMORe has purchased limited retrocession reinsurance. In
August 1998, XLMORe successfully placed $200 million of retrocessional property
catastrophe cover in a combination reinsurance and capital market swap
transaction. The transaction was offered in two tranches and covered the upper
layers, with a remote possibility of attachment, of XLMORe's hurricane and
earthquake exposure in the United States and its territories and possessions in
the Caribbean. The risk securitization structure is unique in that it provides
retrocessional cover in financial swap form, with claim recovery triggered by
catastrophe losses actually incurred by XLMORe rather than by a catastrophe
index or industry size event. For the years ended October 31, 1997 and 1996,
XLMORe participated in limited retrocessions. Initially, the majority of such
retrocessions originated from common account reinsurance on assumed business.
NAC's 1998 reinsurance program for multiple claims arising from two or more
risks in a single occurrence or event is summarized below:
PROPERTY--Property business is protected by two sets of retrocessional
agreements. The first set of agreements provides protection for a total of
$97 million in excess of an initial retention of $5 million for loss events
within the United States and Canada. NAC's retention gradually increases up
to an additional $3 million should gross losses exceed $60 million. The
second set of agreements provides protection for loss events that occur
outside of United States and Canada for 100% of $65 million in excess of an
initial retention of $5 million. Both sets of agreements are on a first and
second event basis.
WORKERS' COMPENSATION--100% of $195 million in excess of a $5 million
retention for any one occurrence.
CASUALTY CONTINGENCY COVER--100% of $25 million in excess of $5 million
for any one occurrence.
In addition to the above reinsurance protections, NAC has coverage in the
event the accident year claims and claims expense ratio exceeds a predetermined
amount.
8
<PAGE>
NAC's 1997 reinsurance program is substantially similar to the 1998 program,
with the exception that property business is protected by a series of
retrocessional agreements which provide protection for 100% of $115 million in
excess of $5 million on a first and second event. Within NAC's $115 million of
catastrophe protection, $25 million of protection in excess of the first
$55 million of protection is available only if industry-wide claims exceed
certain minimum levels.
Further, in recognition of NAC's surplus position and financial capacity,
and the continued positive contribution of business written since 1986, NAC
terminated two retrocessional programs effective January 1, 1997. NAC received
total consideration of approximately $225 million representing reinsurance
recoverable balances for unpaid claims and claims expenses of approximately the
same amount. The termination of these programs has resulted in an increase in
net retention levels for the years 1996 and prior. Particularly as the casualty
book of business matures, the increase in net retentions for these years may
result in increased volatility in future years to the extent the actual
frequency and severity of claims differs from management's current estimates.
The Company believes its exposure to such volatility is within acceptable
levels.
LLOYD'S OPERATIONS
Brockbank, as part of its business strategy, has historically purchased a
significant amount of reinsurance for its syndicates, including the corporate
syndicates. Corporate syndicate 1209 benefits from the same reinsurance programs
as its parallel syndicates 861 and 588. Reinsurance is purchased to protect the
syndicates against extraordinary loss or loss involving one or more underwriting
classes. The amount purchased is determined with reference to the syndicates
aggregate exposure and potential loss scenarios.
Corporate syndicate 2253 benefits from the same reinsurance programs as its
parallel syndicate 253. Reinsurance is purchased on a quota share and excess of
loss basis.
See "Management's Discussion and Analysis of Financial Condition and Results
of Operations" for further discussion on the Company's premium revenues.
COMPETITION
The worldwide property and casualty insurance and reinsurance industry is
highly competitive. The markets for the Company's insurance and reinsurance
products are characterized by strong, and at times intense price competition
driven largely by the substantial amount of excess capacity currently present in
the industry. The Company believes that such competitive forces will be present
in the industry over the short to medium term.
Whereas only a small number of insurers used to compete with the Company's
property and casualty lines of business at the attachments and limits offered by
it, the Company currently estimates there to be at least 12 competitors
worldwide with respect to such business. Similarly, the Company believes there
to be a large number of reinsurers which compete with its reinsurance
subsidiaries. Many of the Company's competitors possess significantly greater
financial and other resources than the Company. The Lloyd's market is also
characterized by a significant number of competitors. The Company generally
competes on the basis of financial strength, coverage terms, claims paying
rating and reputation, price, and customer service.
See Industry Overview included in the "Management's Discussion of Financial
Condition and Results of Operations" for a discussion of current market
conditions.
9
<PAGE>
UNDERWRITING AND MARKETING
UNDERWRITING
XLI and XLE write liability and property coverage for a wide array of
industry groups, including chemical, industrial, pharmaceutical, property
owners, landlords and tenants, utilities, auto, consumer, rail, oil and
construction with respect to third-party general liability and first-party
property; industrial/ manufacturing, utilities, chemical/pharmaceutical and
financial institutions with respect to directors and officers liability; and
lawyers, insurance brokers and insurance companies for professional liability.
Although rates are influenced by a number of factors, including competition, the
Company's rating methodology seeks to set rates individually for each insured in
accordance with claims potential as measured by past experience and future
expectations, the attachment point and amount of underlying insurance, the
nature and scope of insured operations (including the industry group in which
the insured operates), exposures to loss, and other specific risk factors
relevant in the judgment of the underwriters and insurance market conditions.
Underwriters separately evaluate each industry category (and sub-groups within
each category) and premiums are set and adjusted for an insured based in large
part on the industry group in which the insured is placed and the insured's risk
relative to the other risks in the insured's industry group. Each industry group
is reviewed annually to take into account outstanding case losses and new loss
incident reports within each group. Rates may vary significantly according to
the industry group of the insured as well as within the group.
XLMORe employs an analytical approach to underwriting designed to specify an
adequate premium for a given exposure that is intended to be commensurate with
the amount of capital it anticipates placing at risk. For its property
catastrophe reinsurance business, XLMORe has developed underwriting guidelines
under which it generally limits the amount of exposure it will directly
underwrite for any one reinsured and the amount of the aggregate exposure to
catastrophic losses in any geographic zone. XLMORe believes it has defined zones
such that a single occurrence, such as an earthquake or hurricane, generally
should not affect more than one zone. The definition of XLMORe's zones are
subject to periodic review and change. XLMORe also generally seeks an attachment
point for its property catastrophe reinsurance anticipated to be high enough to
produce a low frequency of loss. XLMORe seeks to limit its aggregate exposure in
the retrocessional and pro rata business because it is sometimes difficult to
allocate risks associated with such business to specific geographic areas.
As part of its underwriting process, XLMORe typically assesses a variety of
factors, including: the reputation of the proposed cedent and the likelihood of
establishing a long-term relationship with the cedent; the geographic area in
which the cedent does business and its market share; a detailed assessment of
catastrophe and risk exposures; historical loss data for the cedent and, where
available, for the industry as a whole in the relevant regions, in order to
compare the cedent's historical catastrophe loss experience to industry
averages; and the perceived financial strength of the cedent.
Underwriting opportunities presented to NAC are evaluated based upon a
number of factors, including the type and layer of risk to be assumed, actuarial
evaluation of premium adequacy, the primary insurer's underwriting and claims
experience, the primary insurer's financial condition and claims paying rating,
NAC's exposure and experience with the primary insurer and the line of business
to be underwritten. NAC will also perform on-site underwriting reviews of the
primary insurers where deemed necessary to determine the quality of a current or
prospective client's underwriting operation.
At Brockbank, the daily acceptance of risk is performed by the active
underwriter, the class underwriters and senior underwriting assistants.
Underwriting authority limits are agreed between the active underwriter, the
class underwriter and the managing agency's board of directors. Underwriters may
delegate underwriting authority on a contractual basis to individuals who are
approved and monitored by Brockbank and (with the exception of U.K. binding
authority holders) tribunalized by Lloyd's. Brockbank syndicates also
participate on market facilities where underwriting authority is delegated to
the lead insurer.
10
<PAGE>
As part of the underwriting process, all of the Company's insurance and
reinsurance underwriting operations, including Lloyd's, evaluate potential
exposures to claims, losses and defense costs associated with Year 2000-related
issues. Such claims, losses and costs, to the extent that they materialize,
could have a material adverse affect on the Company's results of operations and
financial condition. For more information concerning the impact of Year 2000
issues on underwriting results, see "Management's Discussion and Analysis of
Results of Operations and Financial Condition--Year 2000 Considerations" and
"--Cautionary Note Regarding Forward-Looking Statements"
MARKETING
Clients are referred to the Company's subsidiaries through a large number of
insurance brokers who receive from the insured or ceding company a brokerage
commission equal to a percentage of gross premiums. In general, subsidiaries of
the Company are not committed to accept business from any particular broker, and
brokers do not have the authority to bind any subsidiary of the Company, except
in the case of Brockbank, where underwriting authority may be delegated to
selected administrators. These administrators are subject to a financial and
operational review prior to any delegation of authority. Brockbank also carries
out ongoing reviews as necessary.
During 1998, 1997 and 1996, approximately 34%, 35% and 34% of the Company's
consolidated gross written premiums were generated from or placed by Marsh
McLennan Companies and its subsidiaries. During 1998, 1997 and 1996,
approximately 19%, 18% and 21% of the Company's consolidated gross written
premiums were generated from or placed by AON corporation and its subsidiaries.
Concentration in the insurance and reinsurance brokerage industry could have a
material adverse effect on the Company's business and results of operations in
the future. See "Management's Discussion and Analysis of Results of Operations
and Financial Condition--Cautionary Note Regarding Forward-Looking Statements."
No other broker accounted for more than 10% of gross premiums written in each of
the three years ended December 31, 1998.
UNPAID LOSSES AND LOSS EXPENSES
Loss reserves are established due to the significant periods of time that
may lapse between the occurrence of an insured loss, the reporting of the loss
to the Company's operating subsidiaries and the payment of that loss. To
recognize liabilities for unpaid losses, the Company establishes reserves, which
are balance sheet liabilities representing estimates of future amounts needed to
pay claims and related expenses with respect to insured events which have been
reported to the Company. The Company's reserving practices and the establishment
of any particular reserve reflect management's judgement concerning sound
financial practice and do not represent any admission of liability with respect
to any claims made against the Company's subsidiaries.
The method of establishing case reserves for reported claims differs between
the insurance and reinsurance operations. When an insurance claim is reported to
the Company's subsidiaries, its claims personnel determine whether to establish
a "case reserve" for the estimated amount of the ultimate settlement, if any.
The estimate reflects the judgment of claims personnel, based on general
corporate reserving practices and on the experience and knowledge of such
personnel regarding the nature and value of the specific type of claim and,
where appropriate, advice of counsel. Reserves are also established to provide
for the estimated expense of settling claims, including legal and other fees and
the general expenses of administering the claims adjustment process ("loss
expense"). Reinsurance case reserves are established based upon reports received
from insureds and reinsureds supplemented by the Company's case reserve
estimates. Periodically, adjustments to the case reserves may be made as
additional information regarding the claims becomes known or partial payments
are made.
Most of the Company's incurred but not reported ("IBNR") loss reserves are
derived from casualty business written by its insurance subsidiaries. Casualty
business generally has a longer tail than the
11
<PAGE>
Company's other lines of business. IBNR is calculated in two steps. First, case
reserve development is calculated with the use of the loss development factor
("LDF") method. Second, "pure" IBNR is estimated with a frequency and severity
approach. Since coverage is usually triggered when a notice is submitted by the
insured, "pure" IBNR losses exist only when claims with a loss notice develop
into the relevant layers of coverage. The method calculates the ultimate number
of claims (i.e., frequency) via the Bornhuetter-Ferguson technique. The severity
component (average claim size) is developed via a single parameter, pareto loss
distribution, adjusted for average attachment points and limits. The Company
believes the methods presently adopted provide a reasonably objective result as
it is based upon the Company's loss data rather than more theoretical models
often used in the low frequency high layer business the Company writes. However,
such actuarially sound methods coupled with the nature of the risks
underwritten, can lead to subsequent adjustments to reserves that are both
significant and irregular.
Several aspects of the Company's casualty insurance operations complicate
the actuarial reserving techniques for loss reserves as compared to other
insurance operations. Among these aspects are the differences in the policy
forms from more traditional forms, the lack of complete historical loss data for
losses of the same type intended to be covered by the policies and the
expectation that losses in excess of the attachment level of the Company's
policies generally will be characterized by low frequency and high severity,
limiting the utility of claims experience of other insurers for similar claims.
While management believes it has made a reasonable estimate of ultimate losses,
the ultimate claims experience may not be as reliably predicted as may be the
case with other insurance operations, and there can be no assurance that losses
and loss expenses will not exceed the total reserves.
Claims relating to property catastrophe and property risk excess treaties
will generally become known and ascertainable within approximately 18 to
24 months from the date of occurrence giving rise to a claim. Claims under a
significant number of Lloyd's syndicate policies, with the exception of motor,
will generally become known and ascertainable with 36 months of the date of the
occurrence giving rise to the claim. Motor claims not involving personal injury
will generally be known and paid within 12 months of the occurrence giving rise
to the claim. Conversely, claims on the insurance operations develop on average
5 to 8 years from the date of occurrence giving rise to the claim.
Losses and loss expenses are charged to income as incurred. The reserve for
unpaid losses and loss expenses represents the accumulation of case reserves,
loss expense reserves and IBNR. During the loss settlement period, additional
facts regarding individual claims and trends usually will become known. As these
become apparent, it often may become necessary to refine and adjust the reserves
upward or downward from time to time. The final liability nonetheless may be
significantly less than or greater than the prior estimates.
The table below represents the development of GAAP balance sheet unpaid loss
and loss expense reserves for 1988 through 1998. The top line of the table shows
the liability, net of reinsurance recoveries at the balance sheet date for each
of the indicated years. This represents the estimated amounts of net loss and
loss expenses arising in all prior years that are unpaid at the balance sheet
date, including IBNR. The upper portion of the table shows the re-estimated
amount of the previously recorded reserve liability based on experience as of
the end of each succeeding year. The estimate changes as more information
becomes known about the frequency and severity of claims for individual years.
The "Cumulative Redundancy (Deficiency)" line represents the aggregate change in
the estimates over all prior years. The lower portion of the table shows the
cumulative amounts paid as of successive years with respect to that liability.
Conditions and trends that have affected development of liability in the past
may not necessarily occur in the future. Accordingly, it may not be appropriate
to extrapolate future redundancies or deficiencies based on the tables below.
See "Management's Discussion and Analysis of Results of Operations and Financial
Condition--Cautionary Note Regarding Forward-Looking Statements."
12
<PAGE>
ANALYSIS OF CONSOLIDATED LOSS AND LOSS EXPENSE RESERVE DEVELOPMENT
(IN MILLIONS)
<TABLE>
<CAPTION>
1988 1989 1990 1991 1992 1993 1994 1995
-------- -------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
LIABILITY FOR UNPAID LOSSES AND LOSS
EXPENSES, NET OF REINSURANCE
RECOVERIES........................... $673 $1,005 $1,268 $1,486 $1,795 $2,057 $2,482 $2,899
LIABILITY RE-ESTIMATED AS OF:
One year later....................... 677 1,039 1,269 1,468 1,800 2,089 2,455 2,885
Two years later...................... 637 1,030 1,128 1,388 1,830 2,089 2,383 2,546
Three years later.................... 610 935 960 1,299 1,819 2,115 2,190 2,445
Four years later..................... 537 783 910 1,303 1,891 1,972 2,085
Five years later..................... 412 755 858 1,384 1,856 1,950
Six years later...................... 353 775 871 1,384 1,820
Seven years later.................... 373 789 884 1,392
Eight years later.................... 381 811 945
Nine years later..................... 391 867
Ten years later...................... 456
CUMULATIVE REDUNDANCY (DEFICIENCY)..... 217 138 323 94 (25) 107 397 454
CUMULATIVE PAID LOSSES, NET OF
REINSURANCE RECOVERIES,
AS OF:
One year later....................... $ 34 $ 159 $ 223 $ 194 $ 267 $ 256 $ 317 $ 445
Two years later...................... 96 349 307 393 468 521 709 667
Three years later.................... 179 404 403 499 689 865 921 934
Four years later..................... 205 459 456 632 937 1,033 1,110
Five years later..................... 241 481 486 831 1,102 1,198
Six years later...................... 256 504 585 924 1,253
Seven years later.................... 271 598 597 974
Eight years later.................... 282 598 633
Nine years later..................... 284 611
Ten years later...................... 291
<CAPTION>
1996 1997 1998
-------- -------- --------
<S> <C> <C> <C>
LIABILITY FOR UNPAID LOSSES AND LOSS
EXPENSES, NET OF REINSURANCE
RECOVERIES........................... $3,166 $3,609 $4,303
LIABILITY RE-ESTIMATED AS OF:
One year later....................... 2,843 3,354
Two years later...................... 2,704
Three years later....................
Four years later.....................
Five years later.....................
Six years later......................
Seven years later....................
Eight years later....................
Nine years later.....................
Ten years later......................
CUMULATIVE REDUNDANCY (DEFICIENCY)..... 462 255
CUMULATIVE PAID LOSSES, NET OF
REINSURANCE RECOVERIES,
AS OF:
One year later....................... $ 234 $ 458
Two years later...................... 576
Three years later....................
Four years later.....................
Five years later.....................
Six years later......................
Seven years later....................
Eight years later....................
Nine years later.....................
Ten years later......................
</TABLE>
The table below represents the claim development of the gross balance sheet
liability for unpaid losses and loss expenses for the years 1992 through 1998.
ANALYSIS OF CONSOLIDATED LOSS AND LOSS EXPENSE RESERVE DEVELOPMENT
GROSS OF REINSURANCE RECOVERABLES
(IN MILLIONS)
<TABLE>
<CAPTION>
1992 1993 1994 1995 1996 1997 1998
-------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
GROSS LIABILITY FOR UNPAID LOSSES AND LOSS
EXPENSES:......................................... $1,977 $2,269 $2,760 $3,238 $3,623 $3,972 $4,897
Liability re-estimated as of:
One year later.................................... 1,996 2,309 2,764 3,244 3,221 3,763
Two years later................................... 2,037 2,323 2,721 2,872 3,164
Three years later................................. 2,043 2,373 2,494 2,793
Four years later.................................. 2,134 2,198 2,414
Five years later.................................. 2,067 2,208
Six years later................................... 2,065
CUMULATIVE REDUNDANCY
(DEFICIENCY)...................................... (88) 61 346 445 459 209
</TABLE>
13
<PAGE>
The following table presents an analysis of paid and unpaid losses and loss
expenses and a reconciliation of beginning and ending unpaid losses and loss
expenses for the years indicated:
RECONCILIATION OF UNPAID LOSSES AND LOSS EXPENSES
(IN THOUSANDS)
<TABLE>
<CAPTION>
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Unpaid losses and loss expenses at beginning of year..... $3,972,376 $3,623,334 $3,238,156
Unpaid losses and loss expenses recoverable.............. (363,716) (457,373) (339,748)
---------- ---------- ----------
Net unpaid losses and loss expenses at beginning of
year................................................... 3,608,660 3,165,961 2,898,408
Net losses and loss expenses incurred in respect of
losses occurring in:
Current year......................................... 1,085,161 1,056,228 757,934
Prior year........................................... (243,644) (317,379) (18,876)
---------- ---------- ----------
Total net incurred loss and loss expenses.............. 841,517 738,849 739,058
Interest incurred on experience reserves................. 1,798 866 1,752
Net loss reserves acquired............................... 580,879 34,593 28,687
Net loss and loss expenses paid in respect of losses
occurring in:
Current year......................................... 271,738 97,954 56,080
Prior year........................................... 458,433 233,655 445,864
---------- ---------- ----------
Total net paid losses.................................. 730,171 331,609 501,944
Net unpaid losses and loss expenses at end of year....... 4,302,683 3,608,660 3,165,961
Unpaid losses and loss expenses recoverable.............. 593,960 363,716 457,373
---------- ---------- ----------
Unpaid losses and loss expenses at end of year........... $4,896,643 $3,972,376 $3,623,334
========== ========== ==========
</TABLE>
Gross case and loss expense reserves as a component of total reserves in
1998 increased to $2.1 billion from $1.4 billion after the payment of
$0.7 billion in losses. One of the main reasons for the increase relates to the
acquisition of Mid Ocean and its related reserves.
The 1998 current year losses reflect the inclusion of the operations of Mid
Ocean acquired on August 7, 1998. These operations incurred $257.6 million in
net losses in 1998. These losses were largely attributable to Hurricane Georges
and Swiss Air. In addition, losses for Brockbank attach at the primary layers
and therefore are more frequent in nature. Brockbank's losses are also
significantly reinsured.
Prior year incurred losses in 1998 were affected mainly by the release of
insurance reserves established for the Company's professional liability lines.
These reserves were reduced in accordance with updated actuarial estimates. In
addition, reserves were released on certain specialty cover policies for the
years 1995 through 1997 due to the absence of losses that would affect the
Company's layers. In 1998, the Company also experienced favorable development of
its casualty reinsurance business written in 1996 and 1997. Actuarial
assumptions used to establish the liability for losses and loss expenses are
periodically adjusted to reflect comparisons to actual loss and loss expense
development, inflation and other considerations.
The high level of the 1997 current year incurred losses was primarily due to
three new casualty indemnity reserves established in that year. Historically,
such losses have not emerged as quickly. Should actual loss activity prove to be
different these, reserves will be adjusted accordingly. The reduction in 1997
prior year losses was due to the release of $317.4 million in reserves that
related to prior years in accordance with updated actuarial estimates across all
insurance lines.
Due to the nature of the Company's business, adjustments to reserves for
individual years can be irregular and significant. Such adjustments are part of
the normal course of business for the Company. Conditions and trends that have
affected development of liability in the past may not necessarily occur in
14
<PAGE>
the future. Accordingly, it is inappropriate to extrapolate future redundancies
or deficiencies based upon historical experience. See generally "Management's
Discussion and Analysis of Results of Operations and Financial
Condition--Cautionary Note Regarding Forward-looking Statements."
CLAIMS ADMINISTRATION
Claims management for the insurance operations includes the review of
initial loss reports, creation of claims files, administration of claims data
base, generation of appropriate response to claims reports, including
identification and handling of coverage issues, determination of whether further
investigation is required and, where appropriate, retention of claims counsel,
establishment of case reserves, payment of claims and notification to
reinsurers.
At XLMORe, loss notifications are received from brokers, reviewed and
entered into a claims database and loss reserves are established for the
reinsurer's share of the loss. Loss reserves are adjusted based on receipt of
further notifications from brokers. Claims staff at NAC review initial loss
reports and coverage issues, monitor claims handling activities of ceding
companies, establish and adjust claims reserves, and approve payment of claims.
Additionally, claims audits are conducted for both specific claims and overall
procedures at the offices of selected ceding companies.
Claims in respect of business written by corporate syndicates are entered
into a claims database. Losses are primarily notified by various central market
bureaus, such as through a daily electronic data interchange message. Where a
syndicate is a "leading" syndicate on a Lloyd's policy, then it will act with
its underwriters and claims adjusters in dealing with the broker or insured on
behalf of itself and the following market in dealing with the broker or insured
for any particular claim. This may involve appointing attorneys or loss
adjusters. The claims bureaus and the leading syndicate advise movements in loss
reserves to all syndicates participating on the risk. A claims department can
vary the case reserves it records from those advised by the bureaus, and all
adjustments are recorded on the claims system.
Claims in respect of the direct motor business written by corporate
syndicate 2253 are handled by Admiral at two servicing centers in Cardiff and
Swansea, Wales. The majority of accidental damage claims are handled by
Admiral's national network of 135 approved repair centers, most of which have
direct video links with Admiral's internal engineering team. Personal injury
cases are handled by a team of internal specialists who, where necessary,
appoint attorneys from a preferred panel.
INVESTMENTS
The Finance Committee of the Board of XL and management oversee investment
strategy, establish guidelines for the various investment managers and implement
investment decisions with the assistance of such managers. The current
investment strategy seeks to maximize investment income through a high-quality,
diversified portfolio while focusing on preserving principal and maintaining
liquidity. In this regard, at December 31, 1998, the Company's fixed income
investment portfolio includes U.S. and non-U.S. sovereign government
obligations, corporate bonds and other securities, 61% of which were rated Aa or
AA or better by a nationally recognized rating agency. Under current investment
guidelines, up to 30% of the Company's investment portfolio may be invested in
equity securities. Applicable insurance laws and regulations do not impose
material restrictions on the Company's investments, except that certain types of
investments (such as unquoted equity securities, investments in affiliates, real
estate and collateral loans) may not qualify as a "relevant asset" for purposes
of satisfying Bermuda statutory financial requirements or may be subject to
specific U.S. insurance or Lloyd's regulations. The Company did not have an
aggregate investment in a single entity (other than the U.S. government) in
excess of 10% of shareholders' equity at December 31, 1998, 1997 or 1996. The
Company also maintains portfolios of equity securities with the assistance of
investment Managers.
For additional information concerning the Company's investments, see
"Management's Discussion and Analysis of Results of Operations and Financial
Condition--Corporate--Investment Operations."
15
<PAGE>
The following table reflects investment results for the Company for each of
the five years ended December 31, 1998:
<TABLE>
<CAPTION>
NET-PRE PRE-TAX
TAX REALIZED ANNUALIZED
AVERAGE INVESTMENT GAINS EFFECTIVE
YEAR ENDED DECEMBER 31, 1998, INVESTMENTS(1) INCOME(2) (LOSSES) YIELD
- ----------------------------- -------------- ---------- --------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
1998.... $7,762,931 $417,290 $ 211,204 5.38%
1997.... $6,274,946 $345,115 $ 410,658 5.50%
1996.... $5,813,455 $304,823 $ 174,593 5.24%
1995.... $5,203,710 $288,989 $ 131,840 5.55%
1994.... $4,605,062 $261,520 $(100,524) 5.68%
</TABLE>
- ------------------------
(1) Average of the beginning and ending amounts of investments and cash and cash
equivalents net of pending trades for the period. Investment securities are
carried at market value.
(2) After investment expenses, excluding net realized gains (losses).
RATINGS
XLI, XLE, and XLMORe each possess a claims paying rating of "AA" from S&P,
and NAC, Greenwich, Indian Harbor and NAC Re International each possess a "AA-"
claims paying rating from S&P. Each of the above named subsidiaries also has an
"A+" rating from A.M. Best Company, Inc. ("Best").
REGULATION
BERMUDA
The Insurance Act 1978 of Bermuda, amendments thereto and related
regulations (the "Act"), regulates the business of XLI and XLMORe. The Act
imposes on Bermuda insurance companies solvency and liquidity standards and
auditing and reporting requirements and grants to Bermuda's Minister of Finance
powers to supervise, investigate and intervene in the affairs of insurance
companies. XLI and XLMORe are designated as Class 4 insurers under the Act
because they carry on insurance and reinsurance business, including excess
liability business and property catastrophe reinsurance business, respectively.
Class 4 insurers are required to maintain total statutory capital and surplus of
not less than $100 million. Both companies are restricted from paying dividends
in any one financial year in excess of 25% of the prior year's statutory capital
and surplus unless the companies' directors attest such dividends will not cause
the companies to fail to meet their relevant margins. As both companies are
highly capitalized, they are not materially affected by this requirement. In
addition to other regulatory requirements, each Class 4 insurer is required to
appoint a loss reserve specialist, who must be approved by the Minister of
Finance of Bermuda, to review and report on the loss reserves of the insurer on
an annual basis. Other subsidiaries of the Company based in Bermuda, including
XLFA, LARe and Reeve Court, are also subject to regulation under the Act.
REPUBLIC OF IRELAND
XLE. is permitted to cover risks throughout the European Community (subject
to certain restrictions) pursuant to the "Third Directive" relating to non-life
insurance. Its operations, however, are largely restricted to the Republic of
Ireland and are subject to regulation under Irish regulatory authority. The
principal legislation and regulations governing the insurance activities of
Irish insurance companies are the Companies Act of 1963 to 1990 and a range of
Irish Insurance Acts from 1909 through 1995 (together, the "Irish Acts"). In
addition, there is a comprehensive network of regulations and statutory
provisions empowering the making of regulations of which the most relevant are
the European Communities
16
<PAGE>
(Non-Life Insurance) Framework Regulations, 1994, the European Communities
(Insurance Undertakings Accounts) Regulations, 1996 and a range of other
European Communities Regulations and administrative rules (together, the "Irish
Regulations").
XLE's insurance activities are subject to extensive regulation in the
Republic of Ireland, principally under the Irish Acts and Irish Regulations,
which impose on insurers headquartered in the Republic of Ireland minimum
solvency and reserve standards and auditing and reporting requirements and grant
to the Minister for Enterprise, Trade and Employment (the "Irish Minister") wide
powers to supervise, investigate and intervene in the affairs of such insurers.
The Irish Minister's powers and functions are exercised through the Department
of Enterprise and Employment.
UNITED STATES
The Company's U.S insurance and reinsurance subsidiaries are subject to
regulatory oversight under the insurance statutes and regulations of the
jurisdictions in which they conduct business, including requirements as to
premium rates and policy reforms, adequacy of reserves, types and quality of
investments, dividends and changes of control. Any entity wishing to acquire
more than 10% of the voting securities of the Company would require prior
regulatory approval from one or more U.S. state insurance regulatory
authorities. Brockbank, via Lloyd's, is licensed in the states of Illinois and
Kentucky and in the U.S. Virgin Islands ("USVI"). It is also and eligible
surplus lines writer in all states other than Kentucky and USVI, and an
accredited reinsurer in every state other than Michigan. Brockbank Insurance
Services, Inc. is licensed in California as a surplus and specialty lines
broker.
The insurance laws of each state of the United States and of many foreign
countries regulate the sale of insurance within their jurisdictions by alien
insurers, such as XLI and XLMORe, which conduct their businesses in Bermuda. The
Company believes it and its subsidiaries are not in violation of the insurance
laws of any state in the U.S. or any foreign country. From time to time, various
proposals for federal legislation within the United States have been circulated
which could indirectly require the Company's non-U.S subsidiaries to, among
other things, register as surplus lines insurers. The Company believes that its
subsidiaries generally could meet and comply with the requirements to be
registered as surplus lines insurers and such compliance would not have a
material impact on the ability of the Company's subsidiaries to conduct their
businesses. There can be no assurance, however, that the activities of the
Company's subsidiaries will not be challenged in the future or that the
Company's subsidiaries will be able to successfully defend against such
challenges or that legislation will not be enacted that will affect its
subsidiaries ability to conduct their businesses or subject them to additional
U.S regulation.
UNITED KINGDOM
The United Kingdom Financial Services Authority ("UK FSA") regulates
reinsurance entities that are "effecting and carrying on" insurance business in
the United Kingdom. XLMORe, through its London branch, and NAC Re International
"effect and carry on" business in the United Kingdom and are therefore regulated
by the UK FSA.
LLOYD'S
Brockbank and Denham are subject to the regulatory jurisdiction of the
Council of Lloyd's (the "Council") and, as a result of its ownership of
Brockbank and Denham, so is the Company. Unlike other financial markets in the
U.K., Lloyd's is not subject to direct U.K. government regulation through The
Financial Services Act of 1986 but, instead, is self regulating by virtue of The
Lloyd's Act of 1982 through bye-laws, regulations and codes of conduct written
by the Council, which governs the Lloyd's market. Under the Council, there are
two boards, the Market Board and Regulatory Board. The former is led by working
members of the Council and is responsible for strategy and the provision of
services such as premium and claims handling, accounting and policy signing. The
Regulatory Board is responsible for the regulation of the market, compliance and
the protection of policyholders and capital providers.
17
<PAGE>
Under Lloyd's regulations, the approval of the Council has to be obtained
before any person can be a "controller" of a corporate member or a managing
agency. A person would be viewed by Lloyd's as a "controller" if such person
owns 10% or more of the corporate member's or managing agency's outstanding
capital stock. There are further control thresholds of 20%, 33% or 50% whereby a
managing agency or corporate member must notify Lloyd's where a "controller" is
intending to increase its shareholding above any of these thresholds. Lloyd's
then has a period of three months in which to object.
The Company has been approved as a "controller" of its corporate members and
managing agencies. As such, the Company is required to provide certain
declarations and undertakings, directed principally towards ensuring that there
is no direct interference in the conduct of the business of the relevant
managing agency, but there are no provisions in the Lloyd's Act of 1982, the
bye-laws or the regulations which provide for any liabilities of the corporate
members or the Brockbank group as a whole or Denham to be met by the Company. In
addition, a managing agency is required to comply with various capital and
solvency requirements, and to submit to regular monitoring and compliance
procedures. The corporate members are each required to commit a specified amount
approximately equal to 50% of their underwriting capacity on the syndicates to
support underwriting on those syndicates.
The Lloyd's Act of 1982 generally restricts certain direct and indirect
equity cross-ownership between a Lloyd's broker and a Lloyd's managing agent.
OTHER
The Company is subject to regulation in Australia, Singapore, Germany, Spain
and South America as a result of its subsidiaries, representative offices and
branches in such jurisdictions. The Company or its subsidiaries also may become
subject to regulation in jurisdictions not described herein from time to time
based on their activities.
TAX MATTERS
The Company is a Cayman Islands corporation and, except as described below,
neither it nor its non-U.S subsidiaries have ever paid United States corporate
income taxes (other than withholding taxes on dividend income) on the basis that
they are not engaged in a trade or business in the United States; however,
because definitive identification of activities which constitute being engaged
in trade or business in the United States is not provided by the Internal
Revenue Code of 1986 (the "Code"), regulations or court decisions, there can be
no assurance that the Internal Revenue Service ("IRS") will not contend that the
Company or its non-U.S. subsidiaries are engaged in trade or business in the
United States. If the Company or its non-U.S subsidiaries were considered to be
engaged in trade or business in the United States (and, if the Company or such
subsidiaries were to qualify for the benefits under the income tax treaty
between the United States and Bermuda or the Republic of Ireland, such
businesses were attributable to a "permanent establishment" in the United
States), the Company or such subsidiaries could be subject to U.S. tax at
regular tax rates on its taxable income that is effectively connected with its
U.S. trade or business plus an additional 30% "branch profits" tax on such
income remaining after the regular tax, in which case there could be a material
adverse effect on the Company's shareholders' equity and earnings.
Lloyd's names are required to pay U.S income tax on U.S connected income
("U.S. income") written by Lloyd's syndicates in which they participate. Lloyd's
has a closing agreement with the IRS whereby the amount of tax due on this
business is calculated by Lloyd's and remitted directly to the IRS. These
amounts are then charged to the personal accounts of the names in proportion to
their participation in the relevant syndicates. The Company's corporate
syndicates are subject to this arrangement but, as U.K. domiciled companies,
will receive U.K. corporation tax credits for any U.S. income tax incurred up to
the value of the equivalent U.K. corporation income tax charge.
18
<PAGE>
Certain subsidiaries of the Company and certain branches and offices of such
subsidiaries are located in taxable jurisdictions such as the United States, the
United Kingdom, Ireland, Australia, Singapore, Germany, Spain and South America.
The Company pays corporate income taxes and other taxes, including applicable
value added and premium taxes, to which its subsidiaries and their branches and
offices are subject in such jurisdictions.
EMPLOYEES
At December 31, 1998, the Company and its subsidiaries employed
approximately 800 employees. None of the these employees are represented by a
labor union, and the Company believes that its employee relations are excellent.
ITEM 2. PROPERTIES
The Company rents space for its principal executive offices under leases
which expire up to June 2009. Total rents expense for the years ended
December 31 1998, 1997 and 1996 were approximately $9 million, $7 million and
$6 million, respectively. In 1997 the Company acquired commercial real estate in
Bermuda for the purpose of securing long-term office space to meet its
anticipated needs. The Company is in the process of developing this property and
constructing its worldwide headquarters. The total cost of this development,
including the land, is expected to be approximately $110.0 million, of which
approximately $25 million has been spent through December 31, 1998. It is
estimated that the development will be completed sometime in 2001.
ITEM 3. LEGAL PROCEEDINGS
The Company, through its subsidiaries, in common with the insurance and
reinsurance industry in general, is subject to litigation and arbitration in the
normal course of its business. As of December 31, 1998, the Company was not a
party to any material litigation or arbitration other than as routinely
encountered in claims activity, none of which is expected by management to have
a material adverse effect on the Company's financial condition.
The Company, Mid Ocean and the directors of Mid Ocean were named as
defendants in a purported class action lawsuit (the "Shareholder Action") filed
in connection with the Arrangements in the Supreme Court, County of New York,
State of New York (the "Supreme Court"). HARBOR FINANCE PARTNERS VS NEWHOUSE, et
al., C.A No. 1998/601266. The Shareholder Action alleges that the defendants
breached their fiduciary duties to the Mid Ocean shareholders by failing to
exercise independent business judgement (due to their alleged conflict of
interest) and by agreeing to sell Mid Ocean at an unfair and inadequate price.
The Shareholder Action was brought on behalf of a purported class of persons
consisting of Mid Ocean shareholders other than the defendants. As relief, the
Shareholder Action seeks, among other things, an order enjoining consummation of
the Arrangements, or, in the event the Arrangements are consummated, rescission
of the Arrangements, and an award of compensatory damages in an unspecified
amount, as well as costs, including fees for plaintiffs' counsel and experts'
fees and expenses. On January 25, 1999, the Supreme Court granted the
defendants' motion to dismiss the Shareholder Action on the grounds that the
Shareholder Action (i) failed to state a claim upon which relief may be granted
under Cayman Islands law and (ii) was not brought in an appropriate forum (FORUM
NON CONVIENS). The Supreme Court's decision is subject to appeal.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of stockholders during the fourth
quarter of the fiscal year covered by this report.
19
<PAGE>
EXECUTIVE OFFICERS OF THE COMPANY
The table below sets forth the names, ages and titles of the persons who
were the executive officers of the Company for the year ended December 31, 1998.
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- -------- ------------------------------------------
<S> <C> <C>
Brian M. O'Hara........................... 50 President, Chief Executive Officer and
Director of the Company
Robert R. Lusardi......................... 42 Executive Vice President and Chief
Financial Officer of the Company.
Robert J. Cooney.......................... 44 Executive Vice President of the Company
and President and Chief Operating Officer
of XLI.
Henry C. V. Keeling....................... 43 Executive Vice President of the Company
and President and Chief Executive Officer
of XLMORe
Mark E. Brockbank......................... 46 Executive Vice President of the Company
and Chief Executive Officer of Brockbank
K. Bruce Connell.......................... 46 Executive Vice President of the Company
and Chief Executive Officer of XL Capital
Products Ltd
Christopher V. Greetham................... 54 Executive Vice President and Chief
Investment Officer of the Company
Paul S. Giordano.......................... 36 Senior Vice President, Secretary and
General Counsel of the Company, XLI and
XLMORe
</TABLE>
Brian M. O'Hara has been President and Chief Executive Officer of the
Company since 1994 and a Director of the Company since 1986, having previously
served as Vice Chairman of the Company from 1987. He is Chairman of XLI and
XLMORe and was Chief Executive Officer of XLI until 1998, having previously
served as Chairman, President and Chief Executive Officer from 1994, President
and Chief Executive Officer from 1992, and as President and Chief Operating
Officer from 1986.
Robert R. Lusardi has been Executive Vice President and Chief Financial
Officer of the Company since February 1998. Prior to joining the Company,
Mr. Lusardi was Managing Director at Lehman Brothers from 1980 to 1998.
Robert J. Cooney has been Executive Vice President of the Company since
March 1995 and President and Chief Executive Officer of XLI since August 1998,
having previously served as President and Chief Operating Officer from December
1995, as Executive Vice President and Chief Underwriting Officer of XLI from
1992, and as a Senior Vice President from 1987. Mr. Cooney resigned from the
Company in July 1999.
Henry C. V. Keeling has been Executive Vice President of the Company and
Chief Executive Officer of XLMORe since August 1998. Mr. Keeling was President,
Chief Operating and Underwriting Officer of MORe from 1992 to 1998, and
previously served as a director of Taylor Clayton (Underwriting Agencies) Ltd.
and deputy underwriter for syndicate 51 at Lloyd's from 1984 through 1992.
Mark E. Brockbank has been Executive Vice president of the Company since
August 1998. Mr. Brockbank has been employed at Lloyd's since 1974 when he
joined Willis Faber Dumas as a marine
20
<PAGE>
broker. He became underwriter of syndicate 861 in 1983. He was appointed a
Director of Brockbank Syndicate Management Ltd in 1983 and of The Brockbank
Group plc in 1988.
K. Bruce Connell has been Executive Vice President of the Company since
March 1998 and is President and Chief Executive Officer of XL Capital Products
Ltd. Mr. Connell previously served as President and Chief Operating Officer of
XLGRe from November 1997 to August 1998, President of XLGRe from December 1995
and as Senior Vice President of XLI from 1990 to 1995.
Christopher V. Greetham has been Executive Vice President of the Company
since December 1998 and has served as Chief Investment Officer of the Company
since 1996. Prior to joining the Company, Mr. Greetham served as Senior Vice
President and Chief Financial Officer of OIL Insurance Ltd. from 1982 to 1996
and as Vice President of Bankers Trust Company from 1975 to 1982.
Paul S. Giordano has been Senior Vice President and General Counsel of the
Company, XLI and XLMORe since January 1997. Mr. Giordano was appointed Secretary
of the Company on December 31, 1997. Mr. Giordano was associated with major law
firms in New York and London prior to joining the Company.
21
<PAGE>
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
(a) The Company's Class A ordinary shares, $0.01 par value, are listed on
the New York Stock Exchange under the symbol XL.
The following table sets forth the high and low closing sales prices per
share of the Company's Class A ordinary shares per fiscal quarter, as reported
on the New York Stock Exchange Composite Tape.
<TABLE>
<CAPTION>
HIGH LOW
-------- --------
<S> <C> <C>
1997:
1st Quarter............................................. $45.000 $37.125
2nd Quarter............................................. 53.000 39.000
3rd Quarter............................................. 61.437 53.063
4th Quarter............................................. 64.688 56.750
1998:
1st Quarter............................................. $77.500 $59.625
2nd Quarter............................................. 80.813 72.250
3rd Quarter............................................. 83.250 62.125
4th Quarter............................................. 77.688 63.938
</TABLE>
Each Class A ordinary share has one vote, except that if, and so long as,
the Controlled Shares of any person constitute ten percent (10%) or more of the
issued Class A ordinary shares, the voting rights with respect to the Controlled
Shares owned by such person shall be limited, in the aggregate, to a voting
power of approximately 10%, pursuant to a formula specified in the Articles of
Association. "Controlled Shares" shall include, among other things, all Class A
ordinary shares for which such person is deemed to beneficially own directly,
indirectly or constructively (within the meaning of Section 13(d)(3) of the
Securities Exchange Act of 1934).
(b) The approximate number of record holders of Class A ordinary shares as
of December 31, 1998 was 800.
(c) The Company paid four regular quarterly dividends in 1997, three of
$0.32 per share to shareholders of record at February 6, April 22 and July 11
and one of $0.40 per share to shareholders of record at September 25.
The Company paid four regular quarterly dividends in 1998, three of $0.40
per share to all shareholders of record on February 6, April 16, and July 15 and
one of $0.44 per share to all shareholders of record on September 28.
The declaration and payment of future dividends by the Company will be at
the discretion of the Board of Directors and will depend upon many factors,
including the Company's earnings, financial condition, business needs, capital
and surplus requirements of the Company's operating subsidiaries and regulatory
restrictions.
As a holding company, the Company's principal source of income is dividends
or other statutorily permissible payments from its subsidiaries. The ability to
pay such dividends is limited by the applicable laws and regulations of Bermuda,
the United States, and the United Kingdom, including those promulgated by the
Society of Lloyds. In order to pay dividends, the amount of which is limited to
accumulated net realized profits, XLI and XLMORe must maintain certain minimum
levels of share capital, solvency and liquidity pursuant to Bermuda statutes and
regulations. At December 31, 1998, XLI and XLMORE could have paid dividends in
the amount of approximately $1.8 billion and $1.3 billion, respectively. Neither
the Company nor any of its subsidiaries other than XLI, XLMORe and the Company's
U.S.
22
<PAGE>
insurance and reinsurance subsidiaries had any other restrictions preventing
them from paying dividends. No assurance, however, can be given that the Company
or its subsidiaries will be permitted to pay dividends in the future.
(d) Rights to purchase Class A ordinary shares were distributed as a
dividend at the rate of one Right for each Class A ordinary share held of record
as of the close of business on October 31, 1998. Each Right entitles holders of
XL Class A ordinary shares to buy one ordinary share at an exercise price of
$350. The Rights would be exercisable, and would detach from the Class A
ordinary shares, only if a person or group were to acquire 20 per cent or more
of XL's outstanding Class A ordinary shares, or were to announce a tender or
exchange offer that, if consummated, would result in a person or group
beneficially owning 20 per cent or more of XL's Class A ordinary shares. Upon a
person or group without prior approval of the Board acquiring 20 per cent or
more of XL's Class A ordinary shares, each Right would entitle the holder (other
than such an acquiring person or group) to purchase XL Class A ordinary shares
(or, in certain circumstances, Class A ordinary shares of the acquiring person)
with a value of twice the Rights exercise price upon payment of the Rights
exercise price. XL will be entitled to redeem the Rights at $0.01 per Right at
any time until the close of business on the tenth day after the Rights become
exercisable. The Rights will expire at the close of business on September 30,
2008, and do not initially have a fair value. The Company has initially reserved
119,073,878 Class A ordinary shares being authorized and unissued for issuance
upon exercise of Rights.
(e) On November 3, 1998, The Company issued 1,066,667 Class A ordinary
shares to FSA in connection with entering into the FSA Joint Venture. The
consideration for the Class A ordinary shares was common stock of FSA. The
transaction was exempt from the registration requirements of the Securities Act
of 1933 by virtue of the exemption provided under Section 4(2) of such Act.
23
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated financial data below includes the results of NAC
Re as required by the pooling of interests accounting and is based upon the
Company's new fiscal year end of December 31. The selected consolidated
financial data should be read in conjunction with the consolidated financial
statements and the notes thereto presented under Item 8.
<TABLE>
<CAPTION>
1998 1997 1996 1995 1994
------------ ----------- ----------- ----------- -----------
(IN THOUSANDS OF U.S. DOLLARS, EXCEPT PER SHARE AND SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
Income Statement Data:
Net premiums earned................... $1,324,291 $1,114,758 $1,038,643 $1,053,748 $918,325
Net investment income................. 417,290 345,115 304,823 288,989 261,520
Net realized gains (losses) on
investments......................... 211,204 410,658 174,593 131,840 (100,524)
Equity in net earnings of
affiliates.......................... 50,292 64,959 59,084 51,074 25,028
Losses and loss expenses.............. 841,517 738,849 739,058 772,096 673,341
Acquisition costs and operating
expenses............................ 436,598 318,107 277,801 269,427 238,600
Interest expense...................... 33,444 29,622 22,322 15,648 14,454
Amortization of intangible assets..... 26,881 7,403 368 368 368
Income before minority interest and
income tax expense.................. 686,962 841,509 537,594 468,113 177,586
Net income............................ 656,330 809,029 516,471 450,080 170,035
Per Share Data:
Net income per share--basic(1)(2)..... $5.86 $7.95 $4.81 $3.82 $1.37
Net income per share--diluted(1)(2)... $5.68 $7.74 $4.73 $3.76 $1.37
Weighted average shares
Outstanding--basic (2).............. 112,034 101,708 107,339 117,833 124,140
Weighted average shares
Outstanding--diluted (2)............ 116,206 105,005 109,908 120,496 126,549
Cash dividends per share (2).......... $1.64 $1.36 $0.95 $0.71 $0.62
Balance Sheet Data:
Total investments..................... $9,057,892 $6,562,609 $5,647,589 $5,234,208 $4,366,691
Cash and cash equivalents............. 480,874 383,594 321,140 787,759 394,591
Investment in affiliates.............. 154,668 524,866 414,891 351,669 230,852
Total assets.......................... 13,581,140 9,070,031 7,823,375 7,424,468 5,859,151
Unpaid losses and loss expenses....... 4,896,643 3,972,376 3,623,334 3,238,156 2,760,462
Notes payable and debt................ 613,873 453,866 323,858 299,927 200,000
Shareholders' equity.................. 5,612,603 3,195,749 2,637,533 2,564,422 2,021,523
Book value per share (2).............. $43.59 $31.55 $25.31 $22.85 $16.42
Fully diluted book value per share
(2)................................. $43.20 $31.42 $25.24 $22.79 $16.42
Operating Ratios:
Loss and loss expense ratio (4)....... 63.5% 66.3% 71.2% 73.3% 73.3%
Underwriting expense ratio (3)........ 31.6% 28.5% 26.7% 25.6% 26.0%
Combined ratio (5).................... 95.1% 94.8% 97.9% 98.9% 99.3%
</TABLE>
- ------------------------
(1) Net income per share is based on the weighted average number of ordinary
shares and ordinary share equivalents outstanding for each period as
required by Statement of Financial Accounting Standard No. 128.
(2) All share and per share information has been retroactively restated to give
effect to a one for one stock dividend paid to XL shareholders of record on
July 26, 1996. Cash dividends per share have not been adjusted for the
pooling effect of NAC Re.
24
<PAGE>
(3) Underwriting expense ratio is the sum of acquisition expenses and operating
expenses divided by net premiums earned. For the year ended December 31,
1998, operating expenses exclude one-time charges of $17.5 million
associated with the merger with Mid Ocean.
(4) Loss and loss expense ratio is calculated by dividing the net losses and
loss expenses incurred by the net premiums earned.
(5) Combined ratio is the sum of the loss and loss expense ratio and the
underwriting expense ratio. A combined ratio of under 100% indicates an
underwriting profit and over 100% indicates an underwriting loss.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
The following is a discussion of the Company's results of operations and
financial condition. Information presented is the combination of the results
formerly presented by XL and NAC Re, as required for a business combination
accounted for by the pooling of interests method, which assumes NAC Re had
always been a part of the Company. It is also based upon the Company's new
fiscal year end of December 31. See note 6 "Business combinations" of the
audited Consolidated Financial Statements for further details. The Company's
results of operations and financial condition for 1998 are significantly
impacted by the acquisition of Mid Ocean in August 1998.
This "Management's Discussion and Analysis of Results of Operations and
Financial Condition" contains forward-looking statements which involve inherent
risks and uncertainties. Statements that are not historical facts, including
statements about our beliefs and expectations, are forward looking-statements.
These statements are based upon current plans, estimates and expectations.
Actual results may differ materially from those projected in such
forward-looking statements, and therefore you should not place undue reliance on
them. See "--Cautionary Note Regarding Forward-Looking Statements" for a list of
factors that could cause actual results to differ materially from those
contained in any forward-looking statement.
This discussion and analysis should be read in conjunction with the audited
Consolidated Financial Statements and notes thereto presented under Item 8.
INDUSTRY OVERVIEW
Abundant capacity and significant price competition continued to
characterize the property and casualty insurance and reinsurance industry (the
"industry") during 1998. Excess capital and limited opportunities for organic
growth in traditional markets continued to generate merger and acquisition
activity as companies attempt to maintain or improve market share and
performance. Perhaps more than ever, the Company together with the industry,
faces a difficult challenge in generating profitable growth.
There has been a shift in both the market landscape and customer demand. The
growth in the Company's traditional lines has slowed as changes and
consolidation in the insurance and reinsurance market have intensified shifts in
customer demand. As a result, innovative and sophisticated ways to handle
increasingly complex risks continue to emerge. Those wanting to meet these
emerging challenges and compete effectively must adapt to the evolving
marketplace and leverage their expertise to assume new roles in the industry
arena. The Company believes that, in common with certain of its competitors, it
is well positioned to take advantage of these and other opportunities.
25
<PAGE>
RESULTS OF OPERATIONS
The following table presents an analysis of the Company's net income for the
years ended December 31, 1998, 1997 and 1996 (U.S. dollars in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Net operating income
(excluding net realized gains on
investments)................................ $457,402 $413,307 $348,727
Net realized gains on investments, after
tax......................................... $198,928 $395,722 $167,744
-------- -------- --------
Net income.................................... $656,330 $809,029 $516,471
======== ======== ========
Earnings per share--basic..................... $ 5.86 $ 7.95 $ 4.81
Earnings per share--diluted................... $ 5.68 $ 7.74 $ 4.73
</TABLE>
Net income decreased in 1998 compared to 1997 and it increased in 1997
compared to 1996 as a result of changes in net realized gains on investments.
Net operating income, which excludes net realized gains on investments,
increased 11.7% to $445.1 million in 1998 from $398.4 million in 1997. Net
operating income increased 16.5% in 1997 compared to 1996. These increases in
net operating income have been primarily due to increases in net underwriting
income and investment income for each of these years.
Basic and diluted earnings per share decreased in 1998 over 1997 due to both
a decrease in net income and a net increase in the weighted average number of
shares issued and outstanding as a result of the issuance of shares in the
acquisition of Mid Ocean. 1997 basic and diluted earnings per share increased
over 1996 due to an increase in the net income and a net reduction in the number
of weighted average shares outstanding due to repurchases of the Company's
shares.
SEGMENTS
At December 31, 1998, the Company is organized into three main operating
segments--insurance, reinsurance--and Lloyd's syndicates and a corporate segment
which includes the investment operations of the Company. See Part I and Item 8,
Note 3 to the Consolidated Financial Statements for further details.
INSURANCE OPERATIONS
The insurance business is written primarily by the following subsidiaries of
the Company: XL Insurance, XL Europe Insurance, XL Insurance Company of America
Inc., Greenwich Insurance and Indian Harbor Insurance. Insurance business
written includes general liability, other liability (including directors and
officers, professional and employment practices liability), property, program
business, marine, aviation, satellite and other product lines (including custom
bond, surety, political risk, specialty lines and financial services). The
Company writes insurance business on both an excess and primary basis, depending
on the particular line of business.
26
<PAGE>
The following table summarizes the underwriting profit (loss) for this
segment (U.S. dollars in thousands):
<TABLE>
<CAPTION>
% CHANGE % CHANGE
1998 98 VS 97 1997 97 VS 96 1996
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Net premiums earned....................... $410,030 (4.4%) $428,774 (6.5%) $458,499
Fee and other income...................... 8,244 NM -- NM --
Losses and loss expenses.................. 267,823 (24.0%) 352,203 (10.9%) 395,366
Acquisition costs......................... 47,688 (13.6%) 55,199 26.8% 43,538
Operating expenses........................ 49,702 33.5% 37,232 (2.8%) 38,321
-------- ----- -------- ----- --------
Underwriting profit (loss)................ $ 53,061 NM $(15,860) 15.3% $(18,726)
======== ===== ======== ===== ========
</TABLE>
- ------------------------
NM = Not meaningful.
The decrease in net premiums earned in the insurance segment in 1998 over
1997 and 1997 over 1996 is mainly due to a decrease of approximately
$80 million and $60 million in the general liability lines, respectively. The
Company continues to experience high levels of competition, particularly on a
price basis and in coverage terms, although business retention has remained in
excess of 80% for the last three years. The Company's response has been to move
generally to higher attachment levels which results in lower premiums as the
Company moves further away from risk.
Partially offsetting this decrease, is an increase in the net premiums
earned in both 1997 and 1998 in the other liability business, which comprises
mostly professional lines. These increases are primarily as a result of several
large tailored programs written, which tend to be complex in nature and often
take a significant period of time to structure. There were also increases in net
premiums earned in 1998 over 1997 in the property, marine, energy, aviation and
satellite lines of business, mainly in the U.S. where there were expanded
opportunities on existing accounts as well as new business.
From time to time, the Company will assist in structuring transactions that
will result in fee income. These transactions tend to be irregular in nature.
Such transactions require an investment of Company resources that are included
in operating expenses.
The changes in the losses and loss expenses, acquisition costs and operating
expenses as shown above are discussed below as part of the analysis of the
Company's underwriting ratios.
The increase in the underwriting profit in 1998 from an underwriting loss in
1997 and 1996 in this segment is due to lower loss and loss expense ratios in
1998 as reflected in the underwriting ratios set forth below. The following
table represents the ratios for this segment for the three years ended
December 31, 1998:
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Loss and loss expense ratio......................... 65.3% 82.1% 86.2%
Underwriting expense ratio.......................... 23.7% 21.6% 17.8%
---- ----- -----
Combined ratio...................................... 89.0% 103.7% 104.0%
==== ===== =====
</TABLE>
The 1998 loss ratio was affected by the reduction of insurance reserves
established for the Company's professional lines to bring them in line with
updated actuarially determined reserve estimates. The Company generally attempts
to establish reserves at the middle to upper end of the relevant actuarial
range, particularly on new lines of business due to the limited loss development
the Company has experienced to date and the long tail nature of certain lines of
cover. In addition, reserves were reduced on
27
<PAGE>
specialty cover policies for the years 1995 through 1997, which expired in 1998,
and where there was an absence of losses on these policies.
The decrease in the loss ratio in 1997 from 1996 reflects the decrease in
net premiums earned in the general liability business year over year. General
liability business typically has a higher loss ratio than the other business
lines in this segment.
The increase in expense ratio over each of the years presented is due to the
decrease in the level of the premiums earned for the same years and additional
operating expenses incurred by the Company in 1998 in establishing its start up
operations in the U.S. and new lines of business.
REINSURANCE OPERATIONS
The reinsurance business is written by XL Mid Ocean Reinsurance, which
writes primarily property lines which are short tail in nature, and NAC, which
primarily writes long tail casualty business. Business written in this segment
includes casualty, property catastrophe, other property, marine, energy,
aviation, satellite and other lines (including political risk and specialty
lines).
The following table summarizes the underwriting profit for this segment
(U.S. dollars in thousands):
<TABLE>
<CAPTION>
% CHANGE % CHANGE
1998 98 VS 97 1997 97 VS 96 1996
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Net premiums earned....................... $760,409 10.8% $685,984 18.2% $580,144
Losses and loss expenses.................. 455,583 17.8% 386,646 12.5% 343,692
Acquisition costs......................... 171,039 19.8% 142,818 6.6% 133,959
Operating expenses........................ 85,541 12.8% 75,829 35.2% 56,068
-------- ----- -------- ---- --------
Underwriting profit....................... $ 48,246 (40.2%) $ 80,691 73.8% $ 46,425
======== ===== ======== ==== ========
</TABLE>
Increases in net premiums earned in 1998 over 1997 is primarily due to the
acquisition of Mid Ocean in August 1998. Similarly, increases in net premiums
earned in 1997 over 1996 is primarily due to the acquisition of Global Capital
in 1997. This increase is offset by declines in net premiums earned on the
casualty business in 1998 over 1997 due to increased market competition and
pricing and the Company's decision not to renew accounts that were deemed not to
meet the Company's profitability standards.
Operating expenses increased in 1998 over 1997 and 1997 over 1996 due to the
acquisitions of Mid Ocean and Global Capital respectively.
The changes in the underwriting profit in the reinsurance segment for each
of the three years ended December 31, 1998 are due to changes in the
underwriting ratios as illustrated below.
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Loss and loss expense ratio........................... 59.9% 56.4% 59.2%
Underwriting expense ratio............................ 33.7% 31.9% 32.8%
---- ---- ----
Combined ratio........................................ 93.6% 88.3% 92.0%
==== ==== ====
</TABLE>
The increase in the loss ratio in this segment in 1998 from 1997 reflects
the acquisition of Mid Ocean. During the fourth quarter of 1998, the Company was
affected by losses related to Hurricane Georges and SwissAir. Property
catastrophe business has loss experience which is generally categorized as low
frequency but high severity in nature. Property catastrophe losses generally are
incurred and paid within a short period of time from the covered event. This may
result in volatility in the Company's financial results for any fiscal year or
quarter.
28
<PAGE>
The decrease in the loss ratio in 1997 from 1996 is mainly due to favorable
claims development on the casualty business written since 1986. Actuarial
assumptions are used to establish initial expected loss ratios employed in the
actuarial methodologies from which the reserves for loss and loss expenses are
derived. Such loss ratios are periodically adjusted to reflect comparisons with
actual claims development, inflation and other considerations.
The Company's casualty business includes an element of asbestos and
environmental claims on business written prior to 1986. The Company's reserving
process includes a supplemental evaluation impact on claims liabilities from
exposure to asbestos and environmental claims, including related loss adjustment
expenses. However, the Company's loss and loss expense reserves for such
exposures, net of reinsurance, as of December 31, 1998, 1997, and 1996 are less
than 1% of its total reserves. A reconciliation of the Company's gross and net
liabilities for such exposures for the three years ending December 31, 1998 is
set forth in Note 7 of the Notes to Consolidated Financial Statements.
LLOYD'S SYNDICATES
The Lloyd's operations comprise the Brockbank Group plc ("Brockbank") and
Denham Syndicate Management Limited ("Denham"), both of which were acquired in
1998. Brockbank provides underwriting and other services to five Lloyd's
syndicates, two of which are dedicated corporate syndicates whose capital is
provided by the Company. These syndicates write property, marine and energy,
aviation and satellite, professional indemnity, motor and other specialty lines,
primarily insurance but also reinsurance. Denham provides similar services to
one corporate syndicate whose capital is provided by the Company and which
specializes in liability coverages. Results for Denham were not material during
1998.
The following table summarizes the underwriting profit for this segment
(U.S. dollars in thousands):
<TABLE>
<CAPTION>
1998
--------
<S> <C>
Net premiums earned......................................... $153,852
Fee and other income........................................ 14,081
Losses and loss expenses.................................... 118,111
Acquisition costs........................................... 30,614
Operating expenses.......................................... 14,875
--------
Underwriting profit......................................... $ 4,333
========
</TABLE>
Fee and other income are fees received from the management of Lloyd's
syndicates and profit commissions which are earned based upon the estimated
results of syndicates managed. Profit commissions are determined after an
underwriting year has been closed under Lloyd's rules, which is usually three
years after its inception.
The following table presents the underwriting ratios for this segment:
<TABLE>
<CAPTION>
1998
--------
<S> <C>
Loss and loss expense ratio................................. 76.8%
Underwriting expense ratio.................................. 29.6%
-----
Combined ratio.............................................. 106.4%
=====
</TABLE>
Losses incurred by the corporate syndicates of Brockbank generally attach at
lower levels and are therefore higher in frequency but lower in severity as
compared to the losses relating to the reinsurance and insurance segments of the
Company. Business written in the Lloyd's segment typically has combined ratios
greater than 100%.
29
<PAGE>
In the fourth quarter of 1999, Brockbank sold its two major insurance
businesses, Admiral and Zenith. The Company expects there to be decreases in
premiums, fee income and certain costs. The Company does not expect the overall
profitability of its Lloyd's operations to be materially affected by such sales.
CORPORATE
INVESTMENT OPERATIONS
The following table illustrates the change in net investment income and net
realized gains and losses for the three years ended December 31, 1998. (U.S
dollars in thousands):
<TABLE>
<CAPTION>
% CHANGE % CHANGE
1998 98 VS 97 1997 97 VS 96 1996
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Net investment income................. $417,290 20.9% $345,115 13.2% $304,823
Net realized investment gains......... $211,204 NM $410,658 NM $174,593
Annualized effective yield............ 5.38% -- 5.50% -- 5.24%
</TABLE>
The Company's investment professionals manage the group's portfolio giving
due consideration to individual entity regulatory and collateral requirements.
At December 31, 1998, total investments and cash, net of the payable for
investments purchased, were $8.9 billion, compared to $6.6 billion at
December 31, 1997. The increase is due to the acquisition of cash and
investments included in the purchase of Mid Ocean, as well as the reinvestment
of investment income and realized gains and the strengthening of the bond and
equity markets during the year. However, as the Company's long-tail casualty
insurance business matures over the next three to five years, it is possible
that claims payments may increase due to the additional exposure to events which
occurred in prior years but have not yet been paid. Funds available for
investment may therefore be reduced as compared to prior years due to such
increased claims payments. The Company's fixed income investments (including
short-term investments and cash equivalents) at December 31, 1998 represented
approximately 79% of invested assets and were managed by several independent
investment managers with different strategies. Of the fixed income securities,
approximately 87% are of investment grade, with 61% rated Aa or AA or better by
a nationally recognized rating agency.
The payable for investments purchased increased from $325.9 million at
December 31, 1997 to $633.2 million at December 31, 1998. The increase is the
result of a timing difference as it is the Company's policy to account for its
investments on a trade basis.
The increase in investment income in 1998 over 1997 is due to an increase in
the average asset base, primarily due to the merger with Mid Ocean in
August 1998 and the Company's positive operational cash flow.
Similarly in 1997, the average asset base increased with the acquisition of
GCR in June 1997. Average investment yields were also higher than 1996. The
proportion of equity securities to the fixed income portfolio decreased
marginally in 1997 compared to 1996.
Net realized investment gains in 1998 reflected the strong performance of
both equity and certain sectors of the fixed income markets early in 1998,
offset by price declines in the third quarter, followed by recoveries in the
fourth quarter. Regarding the latter, generally declining interest rates and
sector volatility, with spreads widening in the corporate and mortgage markets,
provided the Company with opportunities to increase the yield on its investments
despite the general decline in interest rates. Also, volatile markets may
promote opportunities for the Company's investment managers to pursue their
total return objectives, generating investment gains in the process.
The equity markets world-wide have remained strong but have been subject to
levels of volatility through the year. This resulted in $150.0 million gains
being realized in 1998 as some of the Company's
30
<PAGE>
equity managers locked in gains where they felt valuations had reached their
targets. The Company also sold a minority investment during the fourth quarter
1998, realizing a $14.1 million gain.
During 1997, both the fixed income and equity portfolios were restructured,
resulting in the above normal turnover of the portfolio and contributing to the
significant gains realized during the year. Market conditions were also very
strong during 1997. The Company also maintains a synthetic equity portfolio
holding S&P 500 Index futures that realized net gains of $23.2 million and
$37.4 million for the years ended December 31, 1998 and 1997, respectively.
OTHER REVENUES AND EXPENSES
The following table sets forth other revenues and expenses of the Company
for the three years ended December 31, 1998 (U.S. dollars in thousands):
<TABLE>
<CAPTION>
% CHANGE % CHANGE
1998 98 VS 97 1997 97 VS 96 1996
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Equity in net earnings of affiliates......... $50,292 (22.6%) $64,959 9.9% $59,084
Amortization of intangible assets............ 26,881 NM 7,403 NM 368
Operating expenses........................... 37,139 NM 7,029 NM 5,915
Interest expense............................. 33,444 12.9% 29,622 32.7% 22,322
Minority interest............................ 749 NM 308 NM --
Income taxes................................. 29,883 (7.1%) 32,172 52.3% 21,123
</TABLE>
The equity in net earnings of affiliates was derived mostly from the
Company's equity position in Mid Ocean, which ended in August 1998 upon the
acquisition of the balance of the outstanding Mid Ocean shares. As a result,
only seven months of earnings were accounted for on this basis in 1998, compared
to a full year in 1997 and 1996.
The increase in equity in net earnings of affiliates in 1997 over 1996
reflects an improvement in reported earnings of Mid Ocean plus contributions of
$3.9 million from the Company's equity positions in Risk Capital Holdings, Inc.
and certain limited partnerships.
The increase in the amortization of intangible assets in 1998 over 1997
relates to the goodwill arising from the Mid Ocean acquisition in 1998.
Similarly, the increase in 1997 over 1996 is due to the goodwill arising from
the acquisition of Global Capital.
Operating expenses in 1998 include $17.5 million of one-time charges
associated with the merger with Mid Ocean Limited. Other increases are due to
the increase in the corporate infrastructure necessary to support the growing
worldwide operations of the Company.
Increases in interest expense in 1998 over 1997 and 1997 over 1996 is due to
the increase in debt outstanding. In 1998 this was used to finance the Mid Ocean
merger and in 1997 the acquisition of Global Capital.
The changes in the income tax expense of the Company mainly reflects the
changes in the profitability of the NAC Re U.S. operations for each year. The
Company's effective tax rate has not changed significantly in each of the three
years ended December 31, 1998. See Note 16 in the Notes to Consolidated
Financial Statements.
FINANCIAL CONDITION AND LIQUIDITY
As a holding company, the Company's assets consist primarily of its
investments in the stock of its subsidiaries and the Company's future cash flows
depend on the availability of dividends or other statutorily permissible
payments from its subsidiaries. The ability to pay such dividends is limited by
the applicable laws and regulations of Bermuda, the United States, Ireland and
the United Kingdom, including those promulgated by Lloyd's which is described
more fully in Note 17 to Consolidated Financial Statements. No assurance,
however, can be given that the Company or its subsidiaries will be permitted to
pay dividends in the future. The Company's shareholders' equity at December 31,
1998 was $5.6 billion, of which $2.9 billion was retained earnings.
31
<PAGE>
In fiscal 1998, 1997 and 1996, the total amount of net losses paid by the
Company was $730.2 million, $331.6 million and $501.9 million, respectively. The
increase is primarily due to the acquisition of Mid Ocean in August 1998.
The Company establishes reserves to provide for the estimated expenses of
settling claims, the general expenses of administering the claims adjustment
process and for losses incurred but not reported. These reserves are calculated
by using actuarial and other reserving techniques to project the estimated
ultimate net liability for losses and loss expenses. The Company's reserving
practices and the establishment of any particular reserve reflect management's
judgement concerning sound financial practice and does not represent any
admission of liability with respect to any claims made against the Company's
subsidiaries. No assurance can be given that actual claims made and payments
related thereto will not be in excess of the amounts reserved.
Inflation can have an effect on the Company in that inflationary factors can
increase damage awards and potentially result in more claims. The Company's
underwriting philosophy is to adjust premiums in response to inflation, although
this may not always be possible due to competitive pressure. Inflationary
factors are considered in determining the premium level on multi-year policies
at the time contracts are written.
As at December 31, 1998, the Company had bank and loan facilities available
from a variety of sources, including commercial banks, totaling $2.24 billion
comprising 364-day facilities, 5-year facilities, notes payable and NAC Re
convertible debentures, other loans and letter of credit facilities. Debt and
notes outstanding at December 31, 1998 were $613.9 million and letters of credit
outstanding were $348.9 million. Letters of credit issued and outstanding, most
of which were collateralized by the Company's investment portfolio, primarily
support U.S. non-admitted business and the Company's Lloyd's capital
requirements.
During 1998, borrowings and repayments under these facilities were
$655 million and $495 million, respectively. The amount of borrowings in 1998
includes $300 million to fund the cash election available to shareholders in
connection with the Mid Ocean merger. Additional borrowings were made to fund
the Company's U.S operations. The total pre-tax interest expense on notes and
debt outstanding during the year ended December 31, 1998 and 1997 was
$33.4 million and $29.6 million. Associated with the Company's bank and loan
commitments are various loan covenants with which the Company was in compliance,
see Note 9 in the Notes to the Consolidated Financial Statements for further
details.
YEAR 2000 CONSIDERATIONS
The Company is exposed to risks associated with Year 2000 issues in terms of
both the technology systems on which it depends and the underwriting exposures
which it assumes.
In 1997, the Company initiated a project to address Year 2000 issues with
respect to the Company's computer software and information technology systems as
well as its non-information technology systems. The project has two distinct
areas of focus--assessment of the Year 2000 compliance of the Company's
software, systems and technology platforms, and the evaluation of the Year 2000
preparedness of significant third parties with whom the Company conducts
business, including vendors and customers.
At December 31, 1998 the Company had substantially completed its assessment
of Company software and systems and has adopted a plan to implement compliant
components, targeted to be substantially complete by June 1999. The Company
estimates that through December 31, 1998 the remediation and validation efforts
were approximately 50% complete, with the costs through such date aggregating
approximately $4 million. Future costs of remediation are not expected to have a
material impact on the Company's financial position, results of operation or
cash flows, although no assurance can be given in this regard.
32
<PAGE>
The Company recognizes the potential impact of Year 2000 issues from its
service providers and customers. The Company is currently communicating with its
significant service providers to assess their readiness and will address
compliance risks with each new significant vendor. In addition, the Company's
potential exposure to its customers' Year 2000 issues is being reviewed. Formal
contingency plans will not be formulated until the Company has identified
specific areas where there is a substantial risk of Year 2000 problems
occurring, and no such areas are identified as of this date.
All insurance and reinsurance subsidiaries of the Company examine the
potential exposure to Year 2000-related risks associated with the coverages that
they provide. In some instances, Year 2000-related risks are expressly excluded
from or included in certain coverages, and in other instances, coverage in
respect of such risks is neither expressly excluded or included. To the extent
that Year 2000-related risks materialize, participants in the property and
casualty insurance and reinsurance industry, including the Company, could pay or
incur significant claims, losses or defense costs which could have a material
adverse effect on the Company's results of operations and financial condition.
In view of the inherent uncertainties surrounding the likelihood that Year
2000-related risks will materialize and the extent to which such risks will
result in insurance and reinsurance losses, it is not possible at this time to
estimate the Company's potential exposure, if any, to claims associated with
Year 2000-related coverage issues. See generally "--Cautionary Note Regarding
Forward-Looking Statements."
FINANCIAL RISK MANAGEMENT
The Company is exposed to various market risks, including changes in
interest rates and foreign currency exchange rates. Market risk is the potential
loss arising from adverse changes in interest rates and foreign currency
exchange rates. The Company manages its market risks based on guidelines
established by management. The Company does not enter into derivatives or other
financial instruments for trading purposes, but does so for hedging purposes.
This risk management discussion and the estimated amounts generated from the
sensitivity analyses are forward-looking statements of market risk assuming
certain adverse market conditions occur. Actual results in the future may differ
materially from these projected results due to actual developments in the global
financial markets. The analysis methods used by the Company to assess and
mitigate risk should not be considered projections of future events of losses.
See generally "--Cautionary Note Regarding Forward-Looking Statements."
The Company's investment portfolio consists of fixed income and equity
securities, denominated in both U.S. and foreign currencies. Accordingly,
earnings will be affected by changes in interest rates, equity prices and
foreign currency exchange rates.
An immediate 100 basis point adverse shift in the treasury yield curve would
result in a decrease in total return of 5.12% or $354 million on the Company's
fixed income portfolio as of December 31, 1998.
The Company has short-term debt and long-term debt outstanding. Interest
rates on short-term debt are LIBOR based. Accordingly, any changes in interest
rates will affect interest expense.
In evaluating the impact of price changes of the equity portfolio, a 10%
change in equity prices would affect total return by approximately
$130 million.
FOREIGN CURRENCY RISK MANAGEMENT
The Company uses foreign exchange contracts to manage its exposure to the
effects of fluctuating foreign currencies on the value of its foreign currency
fixed maturities and equity investments on an overlay basis. These contracts are
not designated as specific hedges for financial reporting purposes and,
therefore realized and unrealized gains and losses on them are recorded as a
component of net realized gains and losses in the period in which they occur.
These contracts generally have maturities of three months or less. In addition,
where the Company's investment managers are of the opinion that potential
33
<PAGE>
gains exist in a particular currency, a forward contract may not be entered
into. At December 31, 1998, forward foreign exchange contracts with notional
principal amounts totaling $322.4 million were outstanding. The fair value of
these contracts as at December 31, 1998 was $316.2 million with unrealized
losses of $6.2 million. Gains of $17.0 million were realized during the year.
Based on this value, a 10% appreciation or depreciation of the U.S. dollar as
compared to the level of other currencies under contract at December 31, 1998
would have resulted in approximately $23.8 million in unrealized gains and
$41.1 million in unrealized losses.
In addition, the Company also enters into foreign exchange contracts to buy
and sell foreign currencies in the course of trading its foreign currency
investments. These contracts are not designated as specific hedges and generally
have maturities of two weeks or less. As such, any realized or unrealized gains
or losses are recorded in income in the period in which they occur. At
December 31, 1998, the value of such contracts outstanding was not material.
The Company attempts to hedge directly the foreign currency exposure of a
portion of its foreign currency fixed maturity investments using forward foreign
exchange contracts that generally have maturities of three months or less and
are rolled over to provide continuing coverage for as long as the investments
are held. Where an investment is sold, the related foreign exchange sale
contract is closed by entering into an offsetting purchase contract. At
December 31, 1998, the Company had, as hedges, foreign exchange contracts for
the sale of $37.5 million and the purchase of $0.1 million of foreign currencies
at fixed rates, primarily New Zealand Dollars (42% of net contract value),
Norwegian Kroner (34%) and British Pounds (11%). The market value of fixed
maturities denominated in foreign currencies held by the Company as at
December 31, 1998 was $36.3 million.
Unrealized foreign exchange gains and losses on foreign exchange contracts
hedging foreign currency fixed maturity investments are deferred and included in
shareholders' equity. As at December 31, 1998 unrealized deferred losses
amounted to $1.3 million and were offset by corresponding increases in the
dollar value of the investments. Realized gains and losses on the maturity of
these contracts are also deferred and included in shareholders' equity until the
corresponding investment is sold. As at December 31, 1998, realized deferred
losses amounted to $0.7 million.
FINANCIAL MARKET EXPOSURE
The Company also invests in a synthetic equity portfolio of S&P Index
futures with an exposure approximately equal in amount to the market value of
underlying assets held in this fund. As at December 31, 1998, the portfolio held
$148.2 million in exposure to S&P 500 Index futures and underlying assets of
$149.6 million. Based on this value, a 10% increase or decrease in the price of
these futures would have resulted in exposure of $163.0 million and
$133.4 million, respectively. The value of the futures is updated daily with the
change recorded in income as a realized gain or loss. For the year ended
December 31, 1998, net realized gains from index futures totaled $23.2 million
as a result of the 26.7% increase in the S&P Index during the twelve-month
period.
Derivative investments are also utilized to add value to the portfolio where
market inefficiencies are believed to exist. At December 31, 1998, bond and
stock index futures outstanding were $235.6 million with underlying investments
having a market value of $2.1 billion (all managers are prohibited by the
Company's investment guidelines from leveraging their positions). A 10%
appreciation or depreciation of these derivative instruments at that time would
have resulted in unrealized gains and losses of $23.6 million, respectively.
RECENT ACCOUNTING PRONOUNCEMENTS
See note 2 of the Notes to the Consolidated Financial Statements for a
discussion on recent accounting pronouncements.
34
<PAGE>
CURRENT OUTLOOK
The Company believes competition in the property casualty insurance and
reinsurance industry will continue to be strong in 1999, exerting pressure on
rates in general across many product lines. Although the Company believes some
opportunities will exist in 1999 for growth in selected product lines, no
assurances can be made that growth in these lines will be sufficient to offset
the competitive pressures affecting the majority of the Company's product lines.
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
The Private Securities Litigation Reform Act of 1995 ("PSLRA") provides a
"safe harbor" for forward-looking statements. This Form 10-K, the Company's
Annual Report to Stockholders, any proxy statement, any Form 10-Q or Form 8-K of
the Company or any other written or oral statements made by or on behalf of the
Company may include forward-looking statements which reflect the Company's
current views with respect to future events and financial performance. Such
statements include forward-looking statements both with respect to the Company
and the insurance and reinsurance sectors in general (both as to underwriting
and investment matters). Statements which include the words "expect", "intend",
"plan", "believe", "project", "anticipate", "will", and similar statements of a
future or forward-looking nature identify forward-looking statements for
purposes of the PSLRA.
All forward-looking statements address matters that involve risks and
uncertainties. Accordingly, there are or will be important factors that could
cause actual results to differ materially from those indicated in such
statements. The Company believes that these factors include, but are not limited
to, the following: (i) ineffectiveness or obsolescence of the Company's business
strategy due to changes in current or future market conditions; (ii) increased
competition on the basis of pricing, capacity, coverage terms or other factors;
(iii) greater frequency or severity of claims and loss activity, including as a
result of natural or man-made catastrophic events, than the Company's
underwriting, reserving or investment practices anticipate based on historical
experience or industry data; (iv) developments in the world's financial and
capital markets which adversely affect the performance of the Company's
investments; (v) changes in regulation or tax laws applicable to the Company,
its subsidiaries, brokers or customers; (vi) acceptance of the Company's
products and services, including new products and services; (vii) changes in the
availability, cost or quality of reinsurance; (viii) changes in the distribution
or placement of risks due to increased consolidation of insurance and
reinsurance brokers; (ix) the impact of the Year 2000-related issues on the
Company's technology systems and underwriting exposures; (x) loss of key
personnel; (xi) the effects of mergers, acquisitions and divestitures;
(xii) changes in rating agency policies or practices; (xiii) changes in
accounting policies or practices; and (xiv) changes in general economic
conditions, including inflation, foreign currency exchange rates and other
factors. The foregoing review of important factors should not be construed as
exhaustive and should be read in conjunction with the other cautionary
statements that are included herein or elsewhere. The Company undertakes no
obligation to publicly update or revise any forward-looking statement, whether
as a result of new information, future developments or otherwise.
35
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
<TABLE>
<CAPTION>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES PAGE
- ------------------------------------------------------------ ----
<S> <C>
Consolidated Balance Sheets as at December 31, 1998 and
1997...................................................... 37
Consolidated Statements of Income and Comprehensive Income
for the years ended
December 31, 1998, 1997 and 1996.......................... 38
Consolidated Statements of Shareholders' Equity for the
years ended December 31, 1998, 1997 and 1996.............. 39
Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996.......................... 40
Notes to Consolidated Financial Statements for the years
ended December 31, 1998, 1997
and 1996.................................................. 41
</TABLE>
36
<PAGE>
XL CAPITAL LTD
CONSOLIDATED BALANCE SHEETS AS AT DECEMBER 31, 1998 AND 1997
(U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
1998 1997
----------- ----------
<S> <C> <C>
ASSETS
Investments:
Fixed maturities, available for sale at fair value
(amortized cost: 1998, $7,433,724; 1997, $5,036,697).... $ 7,512,903 $5,153,787
Equity securities, at fair value (cost: 1998, $1,127,590;
1997, $856,162)......................................... 1,299,098 985,851
Short-term investments, at fair value (amortized cost:
1998, $246,085; 1997, $423,335)......................... 245,891 422,971
----------- ----------
Total investments..................................... 9,057,892 6,562,609
Cash and cash equivalents................................... 480,874 383,594
Investments in affiliates (cost: 1998, $141,590; 1997,
$336,680)................................................. 154,668 524,866
Other investments........................................... 44,085 35,147
Accrued investment income................................... 95,910 84,904
Deferred acquisition costs.................................. 204,271 113,566
Prepaid reinsurance premiums................................ 215,466 134,287
Premiums receivable......................................... 904,203 451,545
Reinsurance balances receivable............................. 124,771 10,646
Unpaid losses and loss expenses recoverable................. 593,960 363,716
Intangible assets........................................... 1,502,828 269,547
Deferred tax asset, net..................................... 37,481 42,646
Other assets................................................ 164,731 92,958
----------- ----------
Total assets.......................................... $13,581,140 $9,070,031
=========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Unpaid losses and loss expenses............................. $ 4,896,643 $3,972,376
Unearned premiums........................................... 1,337,277 824,369
Notes payable and debt...................................... 613,873 453,866
Reinsurance balances payable................................ 183,660 102,753
Net payable for investments purchased....................... 633,181 325,926
Other liabilities........................................... 256,862 168,766
Minority interest........................................... 47,041 26,226
----------- ----------
Total liabilities..................................... $ 7,968,537 $5,874,282
----------- ----------
Commitments and Contingencies
Shareholders' Equity:
Authorized, 999,990,000 ordinary shares, par value $0.01
Issued and outstanding:
Class A ordinary shares (1998: 125,629,257;
1997 : 101,281,811)..................................... 1,256 1,013
Class B ordinary shares (1998: 3,115,873; 1997 : nil)..... 31 --
Contributed surplus......................................... 2,508,062 506,452
Accumulated other comprehensive income...................... 235,185 251,471
Deferred compensation....................................... (22,954) (18,263)
Retained earnings........................................... 2,891,023 2,455,076
----------- ----------
Total shareholders' equity.............................. $ 5,612,603 $3,195,749
----------- ----------
Total liabilities and shareholders' equity.............. $13,581,140 $9,070,031
=========== ==========
</TABLE>
See accompanying notes to Consolidated Financial Statements
37
<PAGE>
XL CAPITAL LTD
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(U.S. DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Revenues:
Net premiums earned.................................... $1,324,291 $1,114,758 $1,038,643
Net investment income.................................. 417,290 345,115 304,823
Net realized gains on sales of investments............. 211,204 410,658 174,593
Equity in net earnings of affiliates................... 50,292 64,959 59,084
Fee and other income................................... 22,325 -- --
---------- ---------- ----------
Total revenues....................................... 2,025,402 1,935,490 1,577,143
---------- ---------- ----------
Expenses:
Losses and loss expenses............................... 841,517 738,849 739,058
Acquisition costs...................................... 249,341 198,017 177,497
Operating expenses..................................... 187,257 120,090 100,304
Interest expense....................................... 33,444 29,622 22,322
Amortization of intangible assets...................... 26,881 7,403 368
---------- ---------- ----------
Total expenses....................................... 1,338,440 1,093,981 1,039,549
---------- ---------- ----------
Income before minority interest and income tax expense... 686,962 841,509 537,594
Minority interest in net income of subsidiary.......... 749 308 --
Income tax expense..................................... 29,883 32,172 21,123
---------- ---------- ----------
Net income............................................... $ 656,330 $ 809,029 $ 516,471
---------- ---------- ----------
Change in net unrealized appreciation of
investments.............................................. (15,414) 6,233 (56,197)
Foreign currency translation adjustments................. (872) (2,388) 7,360
---------- ---------- ----------
Comprehensive Income..................................... $ 640,044 $ 812,874 $ 467,634
========== ========== ==========
Weighted average ordinary shares and ordinary share
equivalents outstanding--basic......................... 112,034 101,708 107,339
========== ========== ==========
Weighted average ordinary shares and ordinary share
equivalents outstanding--diluted....................... 116,206 105,005 109,908
========== ========== ==========
Earnings per ordinary share and ordinary share
equivalent--basic...................................... $ 5.86 $ 7.95 $ 4.81
========== ========== ==========
Earnings per ordinary share and ordinary share
equivalent--diluted.................................... $ 5.68 $ 7.74 $ 4.73
========== ========== ==========
</TABLE>
See accompanying notes to Consolidated Financial Statements
38
<PAGE>
XL CAPITAL LTD
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(U.S. DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Ordinary Shares:
Balance-beginning of year.............................. $ 1,013 $ 1,039 $ 649
Issue of shares........................................ 15 6 7
Issue of shares--Mid Ocean acquisition................. 291 -- --
Stock dividend......................................... -- -- 441
Exercise of stock options.............................. 3 4 6
Repurchase of treasury shares.......................... (35) (36) (64)
---------- ---------- ----------
Balance-end of year.................................. 1,287 1,013 1,039
---------- ---------- ----------
Contributed Surplus:
Balance-beginning of year.............................. 506,452 500,599 525,771
Issue of shares........................................ 101,502 18,917 11,873
Issue of shares Mid Ocean acquisition.................. 2,093,426 -- --
Exercise of stock options.............................. 9,147 6,277 6,045
Repurchase of treasury shares.......................... (202,465) (19,341) (43,090)
---------- ---------- ----------
Balance-end of year.................................. 2,508,062 506,452 500,599
---------- ---------- ----------
Accumulated other comprehensive income:
Balance-beginning of year.............................. 251,471 247,626 296,463
Net change in investment portfolio, net of tax......... (10,352) (8,302) (58,940)
Net change in investment portfolio of affiliate........ (5,062) 14,535 2,743
Currency translation adjustments....................... (872) (2,388) 7,360
---------- ---------- ----------
Balance-end of year.................................. 235,185 251,471 247,626
---------- ---------- ----------
Deferred Compensation:
Balance-beginning of year.............................. (18,263) (9,825) (11,565)
Issuance of restricted shares.......................... (10,506) (13,675) (682)
Amortization........................................... 5,815 5,237 2,422
---------- ---------- ----------
Balance-end of year.................................. (22,954) (18,263) (9,825)
---------- ---------- ----------
Retained Earnings:
Balance-beginning of year.............................. 2,455,076 1,898,094 1,746,474
Net income............................................. 656,330 809,029 516,471
Cash dividends paid.................................... (156,482) (120,607) (90,898)
Repurchase of treasury shares.......................... (63,901) (131,440) (273,953)
---------- ---------- ----------
Balance-end of year.................................. 2,891,023 2,455,076 1,898,094
---------- ---------- ----------
Total shareholders' equity............................... $5,612,603 $3,195,749 $2,637,533
========== ========== ==========
</TABLE>
See accompanying notes to Consolidated Financial Statements
39
<PAGE>
XL CAPITAL LTD
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(U.S. DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------ -----------
<S> <C> <C> <C>
Cash flows provided by operating activities:
Net income....................................... $ 656,330 $ 809,029 $ 516,471
Adjustments to reconcile net income to net cash
provided by operating activities:
Net realized gains on sales of investments......... (211,204) (410,658) (174,593)
Amortization of (discounts) premium on fixed
maturities....................................... (14,718) (2,170) 7,021
Equity in net earnings of affiliates, net of cash
received......................................... (24,973) (34,395) (44,329)
Amortization of deferred compensation.............. 5,815 5,237 2,422
Amortization of intangible assets.................. 26,881 7,403 368
Unpaid losses and loss expenses.................... 323,857 314,449 385,178
Unearned premiums.................................. 52,161 (193,018) 183,735
Premiums receivable................................ 4,245 151,203 (141,748)
Unpaid losses and loss expenses recoverable........ (221,177) 94,349 (117,625)
Prepaid reinsurance premiums....................... (45,961) (49,328) (55,489)
Reinsurance balances receivable.................... (31,103) 16,419 (8,284)
Other.............................................. 39,783 25,424 14,698
------------ ------------ -----------
Total adjustments................................ (96,394) (75,085) 51,354
------------ ------------ -----------
Net cash provided by operating activities.......... 559,936 733,944 567,825
Cash flows used in investing activities:
Proceeds from sale of fixed maturities and
short-term investments........................... 15,765,103 12,385,521 5,426,401
Proceeds from redemption of fixed maturities and
short-term investments........................... 516,418 187,441 142,800
Proceeds from sale of equity securities............ 918,501 1,381,465 600,475
Purchases of fixed maturities and short-term
investments...................................... (16,460,877) (12,615,821) (6,280,982)
Purchases of equity securities..................... (1,020,032) (1,147,601) (467,252)
Deferred (gains) losses on forward contracts....... (12,163) 8,247 (410)
Investments in affiliates.......................... (1,126) (43,184) (19,131)
Acquisition of subsidiaries, net of cash
acquired......................................... 41,483 (660,137) --
Other investments.................................. 4,411 (6,016) (15,469)
Other assets....................................... 13,430 (54,353) (27,864)
------------ ------------ -----------
Net cash used in investing activities................ (234,852) (564,438) (641,432)
Cash flows used in financing activities:
Issuance of restricted shares...................... 514 387 695
Proceeds from exercise of share options............ 15,092 12,284 4,482
Repurchase of treasury shares...................... (266,401) (154,720) (313,321)
Dividends paid..................................... (156,481) (120,607) (90,898)
Proceeds from loans................................ 655,000 530,000 19,162
Repayment of loans................................. (495,000) (400,000) (13,000)
Minority interest.................................. 19,988 26,226 --
------------ ------------ -----------
Net cash used in financing activities................ (227,288) (106,430) (392,880)
Effects of exchange rate changes on cash on foreign
currency cash balances............................. (516) (622) (132)
Increase (decrease) in cash and cash equivalents..... 97,280 62,454 (466,619)
Cash and cash equivalents-beginning of year.......... $ 383,594 $ 321,140 $ 787,759
------------ ------------ -----------
Cash and cash equivalents--end of year............... $ 480,874 $ 383,594 $ 321,140
============ ============ ===========
Taxes paid........................................... $ 31,200 $ 37,600 $ 23,600
============ ============ ===========
Interest paid........................................ $ 32,800 $ 27,100 $ 22,000
============ ============ ===========
</TABLE>
See accompanying notes to Consolidated Financial Statements
40
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31 1998, 1997 AND 1996
1. HISTORY
XL Capital Ltd ("XL" or the "Company") is a holding company organized under
the laws of the Cayman Islands. XL was incorporated on March 16, 1998, as the
successor to EXEL Limited, a Cayman Islands corporation organized in 1986
("EXEL"), in connection with EXEL's merger with Mid Ocean Limited, a Cayman
Islands corporation ("Mid Ocean"). The merger was accounted for as a purchase
under U.S generally accepted accounting principles ("GAAP") and as such, results
of operations of Mid Ocean are included from August 1, 1998, the effective date
of the merger. In the merger all of the shares of EXEL and Mid Ocean were
exchanged for shares in the Company pursuant to two schemes of arrangement
approved by the Grand Court of the Cayman Islands in accordance with Section 85
of the Companies Law (1995 Revision) of the Cayman Islands. The Company operated
under the name "EXEL Limited" from completion of the merger until February 1,
1999 when its current name was approved by the requisite vote of the Company's
shareholders. References herein to "XL" or the "Company" also shall include EXEL
unless the context otherwise requires. Through its subsidiaries, the Company is
a leading provider of insurance and reinsurance, including coverages relating to
certain financial risks, to industrial, commercial and professional service
firms, insurance companies and other enterprises on a worldwide basis.
In June 1999, XL received regulatory approval to merge with NAC Re Corp.
("NAC Re"). The merger has been accounted for as a "pooling-of-interests" under
U.S. GAAP. Under the pooling of interests accounting it is assumed that XL and
NAC Re have been merged from the date of incorporation of XL. Subsequent to the
merger agreement, XL amended its financial year from November 30 to December 31
to be the same as NAC Re as a conforming pooling adjustment and to facilitate
year end reporting for its subsidiaries. NAC Re is a Delaware corporation that
was organized in June 1985 for the purpose of holding all the outstanding shares
of common stock of NAC Reinsurance Corporation ("NAC"). NAC is a property and
casualty reinsurance company incorporated in New York in 1929. NAC has two
primary insurance subsidiaries, Greenwich Insurance Company ("Greenwich") and
Indian Harbor Insurance Company ("Indian Harbor"). These companies are licensed
to write in all 50 states, the District of Columbia, Puerto Rico and all
provinces of Canada. NAC has a reinsurance subsidiary, NAC Reinsurance
International Limited ("NAC Re International") based in London, England, which
has a branch in Sydney, Australia and a contact office in Madrid, Spain. NAC Re
International writes non-U.S. international property and casualty treaty and
facultative reinsurance business.
XL Insurance Ltd, an insurance company organized under the laws of Bermuda
("XLI"), and its subsidiaries are the Company's principal insurance
subsidiaries. XLI was formed in 1986 in response to a shortage of high excess
liability coverage for Fortune 500 companies in the United States. In 1990, XLI
formed XL Europe Insurance, an insurance company organized under the laws of the
Republic of Ireland ("XLE"), to serve European clients. In 1998, XLI acquired
Folksamerica General Insurance Company (renamed X.L Insurance Company of
America, Inc), an insurance company domiciled in the State of New York and
possessing property and casualty insurance licenses in approximately 20 states
and reinsurance licenses in approximately 14 states, and formed X.L Risk
Solutions, Inc., an insurance company domiciled in the State of Connecticut. XLI
also has a representative office in Australia.
XL Mid Ocean Reinsurance ("XLMORe") is organized under the laws of Bermuda.
On August 7, 1998, XLMORe was formed through the merger of X.L Global
Reinsurance Company, Ltd ("XLGRe") and Mid Ocean Reinsurance Company Ltd.
("MORe"). XLGRe was formed in November 1997 through the merger of X.L
Reinsurance Company, Ltd. ("XLRe") and Global Capital Reinsurance Company
Limited ("GCRe") following EXEL's acquisition of GCR Holdings Limited, a Cayman
Islands holding company, on June 12, 1997. XLRe commenced operations on
December 1, 1995 to write specialty
41
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. HISTORY (CONTINUED)
reinsurance business. MORe and GCRe were organized in 1992 and 1993,
respectively, initially to write property catastrophe reinsurance following
severe hurricanes which struck the southeastern United States in the late 1980's
and early 1990's. XLMORe maintains branches in London, Singapore and a European
contact office in Munich.
The Brockbank Group plc ("Brockbank") was acquired through the merger with
Mid Ocean. Brockbank is a company organized under the laws of England and is a
leading Lloyds managing agency which provides underwriting and similar services
to five Lloyd's syndicates. Two of these syndicates are dedicated corporate
syndicates ("corporate syndicates") whose capital is provided solely by the
Company and its subsidiaries. Mid Ocean acquired 51% of Brockbank in
December 1995 and the remaining 49% in August 1997. The two corporate
syndicates, which commenced operations with effect from January 1, 1996,
underwrite property, marine and energy, aviation, satellite, professional
indemnity U.K motor and other specialty lines of insurance and reinsurance to a
global client base. In 1998, the aggregate premium limit of the two corporate
syndicates was approximately $340 million, and the total capacity under
management by Brockbank was approximately $900 million. As a managing agency,
Brockbank receives fees and commissions in respect of underwriting services it
provides to syndicates.
Denham Syndicate Management Limited was acquired by NAC Re during 1998 and
it also provides underwriting and similar services to one corporate syndicate,
whose capital is provided by the Company. This syndicate writes a specialized
book of international business, concentrating on long-tail casualty and
non-marine physical damage.
The Company participates in several joint ventures of strategic importance.
In general, the Company has pursued a strategy of entering into joint ventures
with organizations which possess expertise in lines of business that the Company
wishes to write. The Company's principal joint ventures are in the areas of
financial guaranty insurance, life insurance for high net worth individuals,
Latin American reinsurance, political risk insurance and currency overlay and
related risk management.
In November 1998, the Company entered into a joint venture with Financial
Security Assurance Holdings Ltd., a New York corporation ("FSA"), to write
certain types of financial guaranty insurance on asset-backed and municipal
obligations. Under the terms of the joint venture, each of the Company and FSA
formed a Bermuda insurance company in which it was the majority shareholder and
made a minority investment in the company formed by its co-venturer. The Company
formed and maintains majority ownership of XL Financial Assurance Ltd ("XLFA").
FSA formed and maintains majority ownership of Financial Security Assurance
International Ltd. (FSAI"). Each of XLFA and FSAI has a capitalization of
approximately $100 million. As part of the joint venture, the Company and FSA
exchanged approximately $80 million of each other's stock, following which the
Company owned approximately 6% of the issued and outstanding common stock of
FSA.
In June 1998, the Company formed Reeve Court Insurance Ltd., an insurance
company organized under the laws of Bermuda, as a joint venture with such
company's management for the purpose of providing life insurance to high net
worth individuals.
In October 1997, the Company and another company formed Latin American
Reinsurance Company Ltd., under the laws of Bermuda ("LARe"). LARe provides
multi-line reinsurance to the Latin American reinsurance market, concentrating
on short-tail, multi-peril property reinsurance, and, to a lesser extent,
casualty, marine, aviation and other lines of reinsurance on both a treaty and
facultative basis. The Company owns approximately 75% of the outstanding shares
of LARC.
42
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. HISTORY (CONTINUED)
In March 1997, XLI became a founding shareholder along with an affiliate of
the Company and another insurance company, of Sovereign Risk Insurance Ltd.
("Sovereign"), a Bermuda-based managing general agency formed to write selected
political risk insurance coverages. The Company owns 40.5% of Sovereign.
In 1996, the Company acquired approximately 30% of Pareto Partners
("Pareto"), a firm which specializes in foreign currency overlay management and
related services. At December 31, 1998, Pareto had approximately $26 billion of
assets under management. The Company works closely with Pareto to develop new
products and ventures.
2. SIGNIFICANT ACCOUNTING POLICIES
(A) BASIS OF PREPARATION
These consolidated financial statements include the accounts of the Company
and all of its subsidiaries and have been prepared in accordance with United
States of America generally accepted accounting principles ("GAAP"). They
include the merger with NAC Re Corp. ("NAC Re"), which occurred in June 1999,
and which has been accounted for as a "pooling-of-interests" under U.S. GAAP.
They are also based upon the Company's new fiscal year end of December 31.
Results of operations, statements of position and cash flows include NAC Re as
though it had always been a part of the Company. All material intercompany
accounts and transactions have been eliminated. The preparation of financial
statements in conformity with GAAP requires management to make estimates and
assumptions that affect the reported amount of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Certain amounts in the financial statements for prior years have been
reclassified to conform with the 1998 presentation. All share amounts have been
adjusted for the one-for-one stock dividend paid to shareholders of record
July 26, 1996.
(B) PREMIUMS AND ACQUISITION COSTS
Premiums written are recorded in accordance with the terms of the underlying
policies. Reinsurance premiums assumed are estimated based upon information
received from ceding companies and any subsequent differences arising on such
estimates are recorded in the period they are determined. Premiums are earned on
a monthly pro-rata basis over the period the coverage is provided. Unearned
premiums represent the portion of premiums written which is applicable to the
unexpired terms of policies in force. Premiums written and unearned premiums are
presented after deductions for reinsurance ceded to other insurance companies.
Acquisition costs which vary with and are primarily related to the
acquisition of policies, primarily commissions paid to insurance brokers, are
deferred and amortized over the period the premiums are earned. Future earned
premiums and the anticipated losses, investment income and other costs related
to those premiums are also considered in determining the level of acquisition
costs to be deferred.
43
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(C) REINSURANCE
In the normal course of business, the Company seeks to reduce the loss that
may arise from events that could cause unfavorable underwriting results by
reinsuring certain levels of risk in various areas of exposure with other
insurance enterprises or reinsurers. Reinsurance premiums ceded and the
commissions recorded thereon are expensed and earned on a monthly pro-rata basis
over the period the reinsurance coverage is provided. Amounts recoverable from
reinsurers are estimated in a manner consistent with the claim liability
associated with the reinsured policy.
(D) INVESTMENTS
Investments are considered available for sale and are carried at fair value.
The fair value of investments is based upon quoted market values where available
or by reference to broker or underwriter bid indications. The net unrealized
appreciation or depreciation on investments is included in accumulated other
comprehensive income.
Short-term investments comprise investments with a maturity equal to or
greater than 90 days but less than one year.
All investment transactions are recorded on a trade date basis. Realized
gains and losses on sales of investments are determined on the basis of average
cost or amortized cost. Investment income is recognized when earned and includes
interest and dividend income together with the amortization of premium and
discount on fixed maturities and short-term investments.
Financial futures and forward currency contracts are carried at fair value,
with the corresponding realized or unrealized gain or loss included in income,
except in the instance of forward foreign currency contracts that are used to
hedge currency risks on specific investments. Gains and losses from these
contracts are deferred and included in shareholders' equity until the
corresponding asset is sold.
(E) FOREIGN CURRENCY TRANSLATION
Assets and liabilities of foreign operations whose functional currency is
other than the US dollar are translated at year end exchange rates. Revenue and
expenses of such foreign operations are translated at average exchange rates
during the year. The effect of the translation adjustments for foreign
operations is recorded, net of applicable deferred income taxes, as a separate
component of accumulated other comprehensive income in shareholders' equity.
Other monetary assets and liabilities denominated in foreign currencies are
translated at the exchange rate in effect at the balance sheet date with the
resulting foreign exchange gains and losses recognized in income, unless the
foreign currency exposure is directly hedged as discussed in note 10. Revenue
and expense transactions are translated at the average exchange rates prevailing
during the year.
(F) INVESTMENTS IN AFFILIATES
Investments in which the Company has significant influence over the
operations of its affiliates are carried under the equity method of accounting.
Under this method, the Company records its proportionate share of income or loss
for such investments in its results of operations.
44
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(G) OTHER INVESTMENTS
The Company accounts for its other investments on a cost basis as it has no
significant influence over these entities. Investments are written down to their
realizable value where management considers there is a permanent decrease in
value. Income is recorded when received.
(H) AMORTIZATION OF INTANGIBLE ASSETS
Intangible assets recorded in connection with the Company's business
combinations are amortized on a straight-line basis over the expected life of
the related operations acquired. The Company evaluates the recoverability of its
intangible assets whenever changes in circumstances warrant. If it is determined
that an impairment exists, the excess of the unamortized balance over the fair
value of the intangible asset will be charged to earnings at that time.
(I) LOSSES AND LOSS EXPENSES
Unpaid losses and loss expenses includes reserves for unpaid reported losses
and loss expenses and for losses incurred but not reported. The reserve for
unpaid reported losses and loss expenses has been established by management in
consultation with independent legal counsel and ceding companies, and represents
the estimated ultimate cost of events or conditions that have been reported to
or specifically identified by the Company. Certain workers' compensation case
reserves are considered fixed and determinable and are subject to tabular
reserving. Such tabular reserves are discounted using an interest rate of 7%.
The Company recognizes as a component of loss reserves, the loss experience
accounts of insurers for policies written on a multi year basis where experience
accounts are a percentage of premiums net of related losses paid. Interest is
earned on liable amounts and charged to investment income. In the event the
insured cancels the policy, the return of the experience account is treated as a
commutation if the Company was previously notified of a loss, or as a return
premium if there has been no loss notification.
The reserve for losses incurred but not reported has been estimated by
management in consultation with independent actuaries and is based on loss
development patterns determined by reference to the Company's underwriting
practices, the policy form and the experience of the relevant insurance
industries.
Management believes that the reserves for unpaid losses and loss expenses
are sufficient to pay any losses that fall within coverages assumed by the
Company. However, there can be no assurance that losses will not exceed the
Company's total reserves. The methodology of estimating loss reserves is
periodically reviewed to ensure that the assumptions made continue to be
appropriate and any adjustments resulting therefrom are reflected in income of
the year in which the adjustments are made.
(J) INCOME TAXES
The Company utilizes the liability method of accounting for income taxes.
Under the liability method, deferred income taxes reflect the net tax effect of
temporary differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for income tax purposes. A
valuation allowance is established for any portion of a deferred tax asset that
management believes will not be realized.
45
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(K) STOCK PLANS
The Company accounts for stock compensation plans in accordance with
Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued
to Employees.". Accordingly, compensation expense for stock option grants and
stock appreciation rights ("SARs") is recognized to the extent that the fair
value of the stock exceeds the exercise price of the option at the measurement
date.
(L) STATEMENTS OF CASH FLOWS
For purposes of the statements of cash flows, cash equivalents include fixed
interest deposits placed with a maturity of under 90 days when purchased.
(M) PER SHARE DATA
Basic earnings per share is based on weighted average common shares
outstanding and excludes any dilutive effects of options and convertible
securities. Diluted earnings per share assumes the conversion of dilutive
convertible securities and the exercise of all dilutive stock options. See
Note 18 for information with respect to the computation of earnings per share.
RECENT ACCOUNTING PRONOUNCEMENTS
During 1998, the following pronouncements were introduced:
The Financial Accounting Standards Board ("FASB") issued Statement of
Financial Accounting Standards ("SFAS") No. 131, "Disclosures about Segments of
an Enterprise and Related Information", effective for fiscal years beginning
after December 15, 1997. This Statement requires that companies report certain
information about their operating segments in the interim and annual financial
statements, including information about the products and services from which
revenues are derived, the geographic areas of operation and information
regarding major customers. The Statement defines operating segments based on
internal management reporting and management's decisions about assessing
performance and allocating resources. The Company has adopted this Statement.
See Note 3 with respect to the Company's operating segments.
FASB issued SFAS No. 132, "Employers' Disclosures about Pensions and Other
Post-retirement Benefits," which is effective for fiscal years beginning after
December 15, 1997. This Statement does not change the recognition or measurement
of pensions or post-retirement benefit plans, but standardizes disclosure
requirements for pensions and other post-retirement benefits. See Note 12 with
respect to the Company's retirement plans.
FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities," which is required to be adopted in years beginning after June 15,
2000. The Company has not yet assessed the affect of the adoption of this
standard on its financial statements.
3. SEGMENT INFORMATION
The Company is organized into three main operating segments--insurance,
reinsurance, Lloyd's syndicates--and a corporate segment that includes the
investment operations of the Company.
46
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. SEGMENT INFORMATION (CONTINUED)
INSURANCE OPERATIONS
The insurance business is written primarily by the following; XL Insurance,
XL Europe Insurance, XL Insurance Company of New York, Greenwich and Indian
Harbor Insurance. Business written includes general liability, other liability
(including directors and officers, professional and employment practices
liability), property, program business, marine, aviation, satellite and other
product lines (including customs, bond surety, political risk, financial
services and specialty lines). The liability insurance is written on an excess
basis and the loss experience is characterized as low frequency and high
severity.
XL Insurance, as part of the financial services business, also offers
insurance and reinsurance solutions for complex financial risks. These include
financial insurance and reinsurance, credit enhancement, swaps and other
collateralized transactions. While each of these are unique and are tailored for
the specific needs of the insured, they are typically multi-year policies. Due
to the nature of these types of policies, premium volume as well as profit
margin can vary significantly from period to period. The Company has approached
this market on a "net-line" perspective, but may cede a portion of some policies
to third parties from time to time.
Through Greenwich and Indian Harbor, the Company also writes primary program
insurance business. The principal lines of business written include certain
specialty classes such as auto warranty business and is written primarily
through managing general agents and general agents.
REINSURANCE OPERATIONS
The Company's reinsurance business is written by NAC and XLMORe.
NAC Re and its subsidiaries are principally engaged in providing treaty and
facultative reinsurance to primary insurers of casualty risks (principally
general liability, professional liability, automobile and workers' compensation)
and commercial and personal property risks and specialty risks (including
fidelity, surety and ocean marine).
XLMORe is a leading reinsurer writing property catastrophe, property excess
of loss, property pro rata, marine and energy, aviation and satellite and
various other reinsurance to insurers on a worldwide basis.
LARe, a subsidiary of XLMORe, provides multi-line reinsurance to the Latin
American market, emphasizing short-tail, multi-peril property reinsurance and,
to a limited extent, casualty, marine, aviation and other lines of reinsurance.
A significant portion of XLMORe's business underwritten consists of large
aggregate exposures to man-made and natural disasters and generally loss
experience is characterized as low frequency and high severity. This may result
in volatility in the Company's financial results. The Company endeavors to
manage its exposures to catastrophic events by limiting the amount of its
exposure in each geographic zone worldwide and requires that its property
catastrophe contracts provide for aggregate limits and varying attachment
points.
47
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. DOLLARS IN THOUSANDS)
3. SEGMENT INFORMATION (CONTINUED)
LLOYD'S SYNDICATES
The Lloyd's operations comprise Brockbank and Denham. Corporate syndicates
managed by Brockbank write property, marine and energy, aviation and satellite,
motor, professional indemnity and other specialty lines, primarily of insurance
but also reinsurance. The Denham syndicate specializes in liability coverages.
The Company evaluates performance of each segment based on net underwriting
profit or loss. Other items of revenue and expenditure of the Company are not
evaluated at the segment level. In addition, management does not consider the
allocation of assets by segment. The following is an analysis of the
underwriting profit or loss by segment together with a reconciliation of
underwriting profit or loss to net income:
<TABLE>
<CAPTION>
LLOYD'S
YEAR ENDED DECEMBER 31, 1998 INSURANCE REINSURANCE SYNDICATES CORPORATE TOTAL
- ---------------------------- --------- ----------- ---------- --------- ----------
<S> <C> <C> <C> <C> <C>
Net premiums earned..................... $410,030 $760,409 $153,852 $ -- $1,324,291
Fee and other income.................... 8,244 0 14,081 -- 22,325
Net losses and loss expenses............ 267,823 455,583 118,111 -- 841,517
Acquisition costs....................... 47,688 171,039 30,614 -- 249,341
Operating expenses (1).................. 49,702 85,541 14,875 19,639 169,757
-------- -------- -------- -------- ----------
Underwriting profit (loss).............. $ 53,061 $ 48,246 $ 4,333 $(19,639) $ 86,001
Net investment income................... 417,290 417,290
Net realized gains on investments....... 211,204 211,204
Equity in net earnings of affiliates.... 50,292 50,292
Interest expense........................ 33,444 33,444
Amortization of intangible assets....... 26,881 26,881
One time charges (1).................... 17,500 17,500
Minority interest....................... 749 749
Income tax expense...................... 29,883 29,883
-------- ----------
Net income.............................. $550,690 $ 656,330
======== ==========
Loss and loss expense ratio............. 65.3% 59.9% 76.8% 63.5%
Underwriting expense ratio.............. 23.7% 33.7% 29.6% 31.6%
-------- -------- -------- ----------
Combined ratio.......................... 89.0% 93.6% 106.4% 95.1%
======== ======== ======== ==========
</TABLE>
- ------------------------
(1) Operating expenses exclude one time charges of $17.5 million associated with
the merger with Mid Ocean Limited.
48
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. DOLLARS IN THOUSANDS)
3. SEGMENT INFORMATION (CONTINUED)
<TABLE>
<CAPTION>
LLOYD'S
YEAR ENDED DECEMBER 31, 1997 INSURANCE REINSURANCE SYNDICATES CORPORATE TOTAL
- ---------------------------- --------- ----------- ---------- --------- ----------
<S> <C> <C> <C> <C> <C>
Net premiums earned..................... $428,774 $685,984 $ -- $ 0 $1,114,758
Net losses and loss expenses............ 352,203 386,646 -- 0 738,849
Acquisition costs....................... 55,199 142,818 -- 0 198,017
Operating expenses...................... 37,232 75,829 -- 7,029 120,090
-------- -------- ---- -------- ----------
Underwriting (loss)profit............... $(15,860) $ 80,691 $ 0 $ (7,029) $ 57,802
Net investment income................... 345,115 345,115
Net realized gains on investments....... 410,658 410,658
Equity in net earnings of affiliates.... 64,959 64,959
Interest expense........................ 29,622 29,622
Amortization of intangible assets....... 7,403 7,403
Minority interest....................... 308 308
Income tax expense...................... 32,172 32,172
-------- ----------
Net income.............................. $744,198 $ 809,029
======== ==========
Loss and loss expense ratio............. 82.1% 56.4% 66.3%
Underwriting expense ratio.............. 21.6% 31.9% 28.5%
-------- -------- ----------
Combined ratio.......................... 103.7% 88.3% 94.8%
======== ======== ==========
</TABLE>
<TABLE>
<CAPTION>
LLOYD'S
YEAR ENDED DECEMBER 31, 1996 INSURANCE REINSURANCE SYNDICATES CORPORATE TOTAL
- ---------------------------- --------- ----------- ---------- --------- ----------
<S> <C> <C> <C> <C> <C>
Net premiums earned..................... $458,499 $580,144 $ -- $ -- $1,038,643
Net losses and loss expenses............ 395,366 343,692 -- -- 739,058
Acquisition costs....................... 43,538 133,959 -- -- 177,497
Operating expenses...................... 38,321 56,068 -- 5,915 100,304
-------- -------- ---- -------- ----------
Underwriting (loss) profit.............. $(18,726) $ 46,425 $ -- $ (5,915) $ 21,784
Net investment income................... 304,823 304,823
Net realized gains on investments....... 174,593 174,593
Equity in net earnings of affiliates.... 59,084 59,084
Interest expense........................ 22,322 22,322
Amortization of intangible assets....... 368 368
Minority interest....................... -- --
Income tax expense...................... 21,123 21,123
-------- ----------
Net income.............................. $488,772 $ 516,471
======== ==========
Loss and loss expense ratio............. 86.2% 59.2% 71.2%
Underwriting expense ratio.............. 17.8% 32.8% 26.7%
-------- -------- ----------
Combined ratio.......................... 104.0% 92.0% 97.9%
======== ======== ==========
</TABLE>
49
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. DOLLARS IN THOUSANDS)
3. SEGMENT INFORMATION (CONTINUED)
SUPPLEMENTAL SEGMENT AND GEOGRAPHIC INFORMATION
The following table is an analysis of the Company's gross premiums written,
net premiums written and earned by product:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------
GROSS PREMIUM WRITTEN: 1998 1997 1996
- ---------------------- ---------- ---------- ----------
<S> <C> <C> <C>
Casualty insurance....................................... $ 411,405 $ 376,837 $ 559,347
Casualty reinsurance..................................... 311,057 348,402 367,080
Property catastrophe..................................... 80,420 (82,294) 65,418
Other property........................................... 315,013 258,957 273,191
Marine, energy, aviation and satellite................... 108,701 84,021 63,212
Lloyd's syndicates....................................... 162,773 -- --
Other.................................................... 254,170 149,462 118,224
---------- ---------- ----------
Total.................................................... $1,643,539 $1,135,385 $1,446,472
========== ========== ==========
</TABLE>
<TABLE>
<CAPTION>
NET PREMIUM WRITTEN: 1998 1997 1996
- -------------------- ---------- -------- ----------
<S> <C> <C> <C>
Casualty insurance......................................... $ 301,362 $265,296 $ 426,951
Casualty reinsurance....................................... 268,460 322,135 336,046
Property catastrophe....................................... 71,380 (82,902) 65,418
Other property............................................. 231,690 191,026 187,290
Marine, energy, aviation and satellite..................... 82,484 68,111 46,912
Lloyd's syndicates......................................... 145,691 -- --
Other...................................................... 223,197 116,779 104,251
---------- -------- ----------
Total...................................................... $1,324,264 $880,445 $1,166,868
========== ======== ==========
</TABLE>
<TABLE>
<CAPTION>
NET PREMIUMS EARNED: 1998 1997 1996
- -------------------- ---------- ---------- ----------
<S> <C> <C> <C>
Casualty insurance....................................... $ 287,438 $ 363,967 $ 406,403
Casualty reinsurance..................................... 282,245 321,394 316,431
Property catastrophe..................................... 122,583 43,519 28,561
Other property........................................... 233,405 189,159 163,044
Marine, energy, aviation and satellite................... 92,147 65,016 38,913
Lloyd's syndicates....................................... 153,852 -- --
Other.................................................... 152,621 131,703 85,291
---------- ---------- ----------
Total.................................................... $1,324,291 $1,114,758 $1,038,643
========== ========== ==========
</TABLE>
The following table shows an analysis of the Company's net premiums written
by geographical location of subsidiary:
<TABLE>
<CAPTION>
NET PREMIUMS WRITTEN: 1998 1997 1996
- --------------------- ---------- -------- ----------
<S> <C> <C> <C>
Bermuda.................................................... $ 534,092 $241,006 $ 515,215
United States.............................................. 497,364 541,362 521,876
Europe and other........................................... 292,808 98,077 129,777
---------- -------- ----------
Total...................................................... $1,324,264 $880,445 $1,166,868
========== ======== ==========
</TABLE>
50
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. DOLLARS IN THOUSANDS)
3. SEGMENT INFORMATION (CONTINUED)
MAJOR CUSTOMERS
During 1998, 1997 and 1996, approximately 34%, 35% and 34% of the Company's
consolidated gross written premiums were generated from or placed by Marsh
McLennan Companies and its subsidiaries. During 1998, 1997 and 1996,
approximately 19%, 18% and 21% of the Company's consolidated gross written
premiums were generated from or placed by AON Corporation and its subsidiaries.
No other broker accounted for more than 10% of gross premiums written in each of
the three years ended December 31, 1998.
4. INVESTMENTS
Net investment income is derived from the following sources:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Fixed maturities, short-term investments and cash and cash
equivalents............................................... $423,612 $346,373 $308,814
Equity securities........................................... 19,596 21,046 19,744
-------- -------- --------
Total investment income................................... 443,208 367,419 328,558
Investment expenses......................................... 25,918 22,304 23,735
-------- -------- --------
Net investment income..................................... $417,290 $345,115 $304,823
======== ======== ========
</TABLE>
51
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. DOLLARS IN THOUSANDS)
4. INVESTMENTS (CONTINUED)
The following represents an analysis of realized and the change in
unrealized appreciation on investments:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Net realized gains (losses):
Fixed maturities and short-term investments:
Gross realized gains...................................... $ 445,086 $ 203,278 $ 89,868
Gross realized losses..................................... (398,046) (167,146) (74,901)
--------- --------- ---------
Net realized gains...................................... 47,040 36,132 14,967
Equity securities:
Gross realized gains...................................... 613,186 400,751 317,650
Gross realized losses..................................... (463,159) (26,225) (158,024)
--------- --------- ---------
Net realized gains...................................... 150,027 374,526 159,626
Net realized gain on sale of investment in affiliate...... 14,137 -- --
--------- --------- ---------
Net realized gains on investments....................... 211,204 410,658 174,593
--------- --------- ---------
Change in unrealized appreciation:
Fixed maturities and short-term investments............... (37,741) 98,212 (103,235)
Equity securities......................................... 41,819 (102,152) 42,691
Deferred gains on forward contracts....................... (13,708) 8,247 (410)
Investment portfolio of affiliates........................ (5,062) 14,535 2,743
Change in deferred income tax liability................... (722) (12,609) 2,014
--------- --------- ---------
Net change in unrealized appreciation
on investments............................................ (15,414) 6,233 (56,197)
--------- --------- ---------
Total net realized and change in unrealized appreciation
on investments........................................ $ 195,790 $ 416,891 $ 118,396
========= ========= =========
</TABLE>
52
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. DOLLARS IN THOUSANDS)
4. INVESTMENTS (CONTINUED)
The cost (amortized cost for fixed maturities and short-term investments),
market value and related unrealized gains (losses) of investments are as
follows:
<TABLE>
<CAPTION>
COST OR GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED MARKET
DECEMBER 31, 1998 COST GAINS LOSSES VALUE
- ----------------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Fixed maturities:
U.S. Government and Government agency......... $1,876,198 $ 19,878 $ (5,310) $1,890,766
Corporate..................................... 3,605,183 80,085 (83,383) 3,601,885
U.S States and political subdivisions of the
States...................................... 1,265,247 60,279 (1,300) 1,324,226
Non-U.S. Sovereign Government................. 687,096 27,229 (18,299) 696,026
---------- -------- --------- ----------
Total fixed maturities...................... $7,433,724 $187,471 $(108,292) $7,512,903
========== ======== ========= ==========
Short-term investments:
U.S. Government and Government agency......... $ 27,816 $ 128 $ -- $ 27,944
Corporate..................................... 200,204 69 (284) 199,989
Non-U.S. Sovereign Government................. 18,065 -- (107) 17,958
---------- -------- --------- ----------
Total short-term investments................ $ 246,085 $ 197 $ (391) $ 245,891
========== ======== ========= ==========
Total equity securities......................... $1,127,590 $242,798 $ (71,290) $1,299,098
========== ======== ========= ==========
DECEMBER 31, 1997
- ------------------------------------------------
Fixed maturities:
U.S. Government and Government agency......... $1,130,190 $ 13,585 $ (958) $1,142,817
Corporate bonds............................... 1,970,780 68,780 (13,343) 2,026,217
U.S States and political subdivisions of the
States...................................... 1,200,314 51,892 (1,233) 1,250,973
Non-U.S. Sovereign Government bonds........... 735,413 18,673 (20,306) 733,780
---------- -------- --------- ----------
Total fixed maturities...................... $5,036,697 $152,930 $ (35,840) $5,153,787
========== ======== ========= ==========
Short-term investments:
U.S. Government and Government agency......... $ 75,442 $ 8 $ -- $ 75,450
Corporate bonds............................... 336,535 187 (203) 336,519
Non-U.S. Sovereign Government bonds........... 11,358 -- (356) 11,002
---------- -------- --------- ----------
Total short-term investments................ $ 423,335 $ 195 $ (559) $ 422,971
========== ======== ========= ==========
Total equity securities......................... $ 856,162 $182,902 $ (53,213) $ 985,851
========== ======== ========= ==========
</TABLE>
The contractual maturities of fixed maturity securities are shown below.
Actual maturities may differ from contractual maturities because borrowers may
have the right to call or prepay obligations with or without call or prepayment
penalties.
<TABLE>
<CAPTION>
DECEMBER 31, 1998
-----------------------
AMORTIZED MARKET
COST VALUE
---------- ----------
<S> <C> <C>
Due after 1 through 5 years.......................... $2,390,830 $2,397,734
Due after 5 through 10 years......................... 2,104,804 2,139,561
Due after 10 through 15 years........................ 1,910,707 1,935,506
Mortgage-backed securities........................... 1,027,383 1,040,102
---------- ----------
$7,433,724 $7,512,903
========== ==========
</TABLE>
53
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. DOLLARS IN THOUSANDS)
4. INVESTMENTS (CONTINUED)
At December 31, 1998, approximately $92 million of securities were on
deposit with various U.S. state or government insurance departments in order to
comply with insurance regulations.
Through its subsidiaries, the Company has two facilities available for the
issuance of letters of credit, which were up to a value of $825 million at
December 31, 1998. These facilities are collateralized against the Company's
investment portfolio. At December 31, 1998, approximately $348.9 million of
letters of credit were issued and outstanding under these facilities.
Included in cash and invested assets at December 31, 1998, are approximately
$22.4 million of assets held in a "holding company" escrow account arising from
a tax allocation agreement between NAC Re and its domestic subsidiaries.
5. INVESTMENTS IN AFFILIATES
The following investments are accounted for on the equity basis:
The Company owned 27.9% of the issued shares of Risk Capital
Holdings, Inc., ("RCHI") as at December 31, 1998 and 1997, respectively.
Outstanding share warrants if exercised would dilute the Company's ownership to
22.1% as at December 31, 1998. RCHI commenced operations on November 6, 1995.
RCHI provides reinsurance and other forms of capital for insurance companies
with capital needs that cannot be met by reinsurance alone.
The Company owns 30% of Pareto Partners, a partnership engaged in the
business of providing investment advisory and discretionary management services.
On November 3, 1998 XL and FSA formed Financial Security Assurance
International Ltd. ("FSAI") under the laws of Bermuda. FSAI was capitalized with
$100 million, of which FSA and XL contributed 80% and 20% respectively. FSAI
will focus on financial guaranty insurance and reinsurance opportunities. As of
December 31, 1998 no contracts had been written.
The Company owned 29.1% of the issued voting shares and 24.8% of the total
issued shares of Mid Ocean as at December 31, 1997. The Company accounted for
its share of Mid Ocean's earnings to July 31, 1998 on an equity basis.
Subsequent to this date, Mid Ocean was acquired by the Company and has been
consolidated as a wholly owned subsidiary of XL.
In June 1997, XLI acquired 21% of Venton from the Trident Partnership L.P.,
of which XL is a 10.7% limited partner. VHL manages three syndicates at Lloyd's
of London which underwrite non-marine, marine and all main classes of business,
respectively. On October 23, 1998, XL sold its investment in VHL to an unrelated
third party for $41.4 million cash, realizing a net gain of $14.1 million.
54
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. DOLLARS IN THOUSANDS)
6. BUSINESS COMBINATIONS AND CHANGE IN FISCAL YEAR END.
a) NAC RE CORP.
On June 18, 1999, the Company completed its merger with NAC Re Corp. ("NAC
Re") in an all stock transaction. Shareholders of NAC Re received 0.915 Company
share for each NAC Re share in a tax free exchange. Approximately 16.9 million
of the Company's Class A ordinary shares were issued in this transaction. The
merger transaction has been accounted for as a pooling of interests under U.S
GAAP. Accordingly, all prior period results of operations, statement of position
and cash flows include the results of NAC Re as though it had always been a part
of the Company.
Following the merger, the Company changed its fiscal year end from
November 30 to December 31 as a conforming pooling adjustment. No adjustments
were necessary to conform NAC Re's accounting policies and certain
reclassifications have been made to the NAC Re financial statements to conform
to the Company's presentation.
The following table presents a reconciliation of the total revenues, net
income, and earnings per share of the Company as previously reported as adjusted
for the change in fiscal year end, together with the combined results of NAC Re:
<TABLE>
<CAPTION>
CONSOLIDATED
CONSOLIDATED CONSOLIDATED SHAREHOLDERS'
DECEMBER 1998 TOTAL REVENUES NET INCOME EQUITY
- ------------- -------------- ------------ -------------
<S> <C> <C> <C>
XL Capital--year end November 30, 1998 as previously
reported............................................. $1,217,648 $587,663 $4,817,880
Less one month December 31, 1997....................... 93,835 57,168 --
Add one month December 31, 1998........................ 202,210 29,785 43,998
---------- -------- ----------
XL Capital--year end December 31, 1998 as adjusted
before combination with NAC Re....................... 1,326,023 560,280 4,861,878
NAC Re--year end December 31, 1998..................... 699,379 96,050 750,725
---------- -------- ----------
Combined results--year end December 31, 1998........... $2,025,402 $656,330 $5,612,603
========== ======== ==========
</TABLE>
<TABLE>
<CAPTION>
BASIC EARNINGS DILUTED EARNINGS
PER SHARE PER SHARE
-------------- ----------------
<S> <C> <C>
XL Capital--year end November 30, 1998 as previously
reported.................................................. $6.32 $6.20
===== =====
XL Capital--year end December 31, 1998 as adjusted before
combination with NAC Re................................... $5.88 $5.77
NAC Re--year end December 31, 1998 (1)...................... $5.74 $5.22
Weighted average combined earnings per share as adjusted.... $5.86 $5.68
===== =====
</TABLE>
- ------------------------
(1) After giving effect to the exchange of 0.915 Company share for each NAC Re
share.
55
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. DOLLARS IN THOUSANDS)
6. BUSINESS COMBINATIONS AND CHANGE IN FISCAL YEAR END. (CONTINUED)
<TABLE>
<CAPTION>
CONSOLIDATED
CONSOLIDATED CONSOLIDATED SHAREHOLDERS'
DECEMBER 1997 TOTAL REVENUES NET INCOME EQUITY
- ------------- -------------- ------------ -------------
<S> <C> <C> <C>
XL Capital--year end November 30, 1997 as previously
reported............................................. $1,159,026 $676,961 $2,479,130
Less one month December 31, 1996....................... 57,743 20,777 --
Add one month December 31, 1997........................ 93,835 57,168 59,558
---------- -------- ----------
XL Capital--year end December 31, 1997 as adjusted
before combination with NAC Re....................... 1,195,118 713,352 2,538,688
NAC Re--year end December 31, 1997..................... 740,372 95,677 657,061
---------- -------- ----------
Combined results--year end December 31, 1997........... $1,935,490 $809,029 $3,195,749
========== ======== ==========
</TABLE>
<TABLE>
<CAPTION>
BASIC EARNINGS DILUTED EARNINGS
PER SHARE PER SHARE
-------------- ----------------
<S> <C> <C>
XL Capital--year end November 30, 1997 as previously
reported.................................................. $7.95 $7.84
===== =====
XL Capital--year end December 31, 1997 as adjusted before
combination with NAC Re................................... $8.40 $8.30
NAC Re--year end December 31, 1997 (1)...................... $5.69 $5.21
Weighted average combined earnings per share, as
adjusted.................................................. $7.95 $7.74
===== =====
</TABLE>
- ------------------------
(1) After giving effect to the exchange of 0.915 Company share for each NAC Re
share.
<TABLE>
<CAPTION>
CONSOLIDATED
CONSOLIDATED CONSOLIDATED SHAREHOLDERS'
DECEMBER 1996 TOTAL REVENUES NET INCOME EQUITY
- ------------- -------------- ------------ -------------
<S> <C> <C> <C>
XL Capital--year end November 30, 1996 as previously
reported............................................. $ 981,951 $494,313 $2,116,038
Less one month December 31, 1995....................... 112,792 69,139 --
Add one month December 31, 1996........................ 57,743 20,777 (31,774)
---------- -------- ----------
XL Capital--year end December 31, 1996 as adjusted
before combination with NAC Re....................... 926,902 445,951 2,084,264
NAC Re--year end December 31, 1996..................... 650,241 70,520 553,269
---------- -------- ----------
Combined results--year end December 31,1996............ $1,577,143 $516,471 $2,637,533
========== ======== ==========
</TABLE>
56
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. DOLLARS IN THOUSANDS)
6. BUSINESS COMBINATIONS AND CHANGE IN FISCAL YEAR END. (CONTINUED)
<TABLE>
<CAPTION>
BASIC EARNINGS DILUTED EARNINGS
PER SHARE PER SHARE
-------------- ----------------
<S> <C> <C>
XL Capital--year end November 30, 1996 as previously
reported.................................................. $5.45 $5.41
===== =====
XL Capital--year end December 31, 1996 as adjusted before
combination with NAC Re................................... $4.95 $4.92
NAC Re--year end December 31, 1996 (1)...................... $4.09 $3.83
Weighted average combined earnings per share, as
adjusted.................................................. $4.81 $4.73
===== =====
</TABLE>
- ------------------------
(1) After giving effect to the exchange of 0.915 Company share for each NAC Re
share.
b) MID OCEAN LIMITED
In August 1998, the Company merged with Mid Ocean Limited ("Mid Ocean").
Shareholders of Mid Ocean received 1.0215 Company share for each Mid Ocean share
subject to a cash election option which was taken up of $96 million. The merger
with Mid Ocean was accounted for as a purchase under U.S. GAAP and as such,
results of operations of Mid Ocean are included from August 1, 1998 which was
deemed the closing date of the transaction. The total purchase price was $2.2
billion, the fair value of Mid Ocean's net assets not already owned by the
Company was $0.9 billion with the balance of $1.3 billion representing goodwill
which is being amortized over 40 years. On August 1, 1998 the following items
were in the consolidated balance sheet of Mid Ocean:
<TABLE>
<S> <C>
Investments available for sale.............................. $1,668,224
Premiums receivable......................................... 445,540
Other assets................................................ 442,831
Total assets................................................ 2,556,595
Unpaid loss and loss expense reserves....................... 595,261
Unearned premium............................................ 458,994
Total liabilities........................................... 1,195,835
Shareholders' equity........................................ 1,360,760
</TABLE>
Cash and cash equivalents totaling $137 million is included in other assets.
The net cash acquired as a result of this merger was $41 million.
See note 21 for further details.
b) GCR HOLDINGS LIMITED
In June 1997, the Company acquired GCR Holdings Limited ("GCR") in an all
cash transaction. The acquisition was accounted for as a purchase under US GAAP,
accordingly results of operations of GCR are included from the closing date of
the transaction. The total purchase price was $667 million, the fair value of
GCR's net assets was $402 million, with the balance of $265 million representing
goodwill which is being amortized over 20 years.
57
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. DOLLARS IN THOUSANDS)
7. LOSSES AND LOSS EXPENSES
Unpaid losses and loss expenses comprise:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
------------------------------------
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Reserve for reported losses and loss expenses............ $2,062,046 $1,416,745 $1,302,263
Reserve for losses incurred but not reported............. 2,834,597 2,555,631 2,321,071
---------- ---------- ----------
Unpaid losses and loss expenses.......................... $4,896,643 $3,972,376 $3,623,334
========== ========== ==========
Losses and loss expenses incurred comprise:
Loss and loss expense payments........................... $849,777 $560,542 $575,510
Change in unpaid losses and loss expenses................ 285,775 344,580 348,014
Reinsurance recoveries................................... (294,033) (166,273) (184,466)
---------- ---------- ----------
Losses and loss expenses incurred........................ $841,517 $738,849 $739,058
========== ========== ==========
</TABLE>
The following table represents an analysis of paid and unpaid losses and
loss expenses and a reconciliation of the beginning and ending unpaid loss and
loss expenses for the years indicated:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
------------------------------------
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Unpaid losses and loss expenses at beginning of year..... $3,972,376 $3,623,334 $3,238,156
Unpaid losses and loss expenses recoverable.............. (363,716) (457,373) (339,748)
---------- ---------- ----------
Net unpaid losses and loss expenses at beginning of
year................................................... 3,608,660 3,165,961 2,898,408
Net losses and loss expenses incurred in respect of
losses occurring in:
Current year....................................... 1,085,161 1,056,228 757,934
Prior year......................................... (243,644) (317,379) (18,876)
---------- ---------- ----------
Total net incurred loss and loss expenses............ 841,517 738,849 739,058
Interest incurred on experience reserves................. 1,798 866 1,752
Net loss reserves acquired............................... 580,879 34,593 28,687
Net loss and loss expenses paid in respect of losses
occurring in:
Current year....................................... 271,738 97,954 56,080
Prior year......................................... 458,433 233,655 445,864
---------- ---------- ----------
Total net paid losses................................ 730,171 331,609 501,944
Net unpaid losses and loss expenses at end of year....... 4,302,683 3,608,660 3,165,961
Unpaid losses and loss expenses recoverable.............. 593,960 363,716 457,373
---------- ---------- ----------
Unpaid losses and loss expenses at end of year........... $4,896,643 $3,972,376 $3,623,334
========== ========== ==========
</TABLE>
The 1998 current year increase in net losses incurred and paid reflects the
inclusion of the operations of Mid Ocean acquired on August 7, 1998. These
operations incurred $257.6 million in net losses in 1998. These losses were
largely attributable to Hurricane Georges and SwissAir.
58
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. DOLLARS IN THOUSANDS)
7. LOSSES AND LOSS EXPENSES (CONTINUED)
Business written by the Company is primarily characterized as low frequency
but high severity in nature. This may result in significant volatility in the
Company's financial results.
Several aspects of the Company's casualty insurance operations complicate
the actuarial reserving techniques for loss reserves as compared to other
insurance operations. Among these aspects are the differences in the policy
forms from more traditional forms, the lack of complete historical loss data for
losses of the same type intended to be covered by the policies and the
expectation that losses in excess of the attachment level of the Company's
policies generally will be characterized by low frequency and high severity,
limiting the utility of claims experience of other insurers for similar claims.
While management believes it has made a reasonable estimate of ultimate losses,
the ultimate claims experience may not be as reliably predicted as may be the
case with other insurance operations, and there can be no assurance that losses
and loss expenses will not exceed the total reserves.
Prior year incurred losses in 1998 were effected mainly by the release of
insurance reserves established for the Company's professional lines. These
reserves were reduced in accordance with updated actuarially determined
reserves. In addition, reserves were released on specialty cover insurance
policies for the years 1995 through 1997 due to the absence of losses that would
affect the Company's layers. The Company also experienced, in 1998, favorable
development of its casualty reinsurance business written in 1996 and 1997.
Actuarial assumptions used to establish the liability for losses and loss
expenses are periodically adjusted to reflect comparisons to actual loss and
loss expense development, inflation and other considerations.
The high level of the 1997 current year incurred losses was primarily due to
three new major 1997 casualty indemnity reserves established. Historically, such
losses have not emerged this quickly. Should actual loss activity prove to be
different these reserves will be adjusted accordingly. The reduction in 1997
prior year losses was due to a release of $317.4 million in reserves that
related to prior years in accordance with updated actuarial estimates across all
insurance lines.
The Company's net incurred losses and loss expenses includes a provision of
$1.2 million, $3.7 million and $1.2 million in 1998, 1997 and 1996 respectively,
for estimates of actual and potential non-recoveries from reinsurers. Such
charges for non-recoveries relate mainly to reinsurance ceded for casualty
business written prior to 1986. Included in unpaid losses and loss expenses at
December 31, 1998, 1997 and 1996 is a reserve for potential non-recoveries from
reinsurers of $14.5 million, $13.8 million and $12.7 million, respectively.
Except for certain workers' compensation unpaid losses, the Company does not
discount its liabilities for unpaid losses and loss expenses. The Company
utilizes tabular reserving for workers' compensation unpaid losses that are
considered fixed and determinable and discounts such losses using an interest
rate of 7% for financial statements prepared in accordance with GAAP and a 5%
interest rate for U.S statutory accounting purposes. The tabular reserving
methodology results in applying a uniform and consistent criteria for
establishing expected future indemnity and medical payments (including an
explicit factor for inflation) and the use of mortality tables to determine
expected payment periods. Tabular unpaid losses and loss expenses, net of
reinsurance, at December 31, 1998, 1997 and 1996 were $61.3 million, $42.4
million and $35.8 million, respectively. The related discounted unpaid losses
and loss expenses were $20.7 million, $16.1 million and $15.0 million as of
December 31, 1998, 1997 and 1996, respectively.
59
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. DOLLARS IN THOUSANDS)
7. LOSSES AND LOSS EXPENSES (CONTINUED)
ASBESTOS AND ENVIRONMENTAL RELATED CLAIMS
The Company's reserving process includes a continuing evaluation of the
potential impact on unpaid liabilities from exposure to asbestos and
environmental claims, including related loss adjustment expenses. Liabilities
are established to cover both known and incurred but not reported claims.
A reconciliation of the opening and closing unpaid losses and loss expenses
related to asbestos and environmental exposure claims for the years indicated is
as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Net unpaid losses and loss expenses at beginning of year.... $32,767 $28,500 $22,029
------- ------- -------
Net incurred loss and loss expenses......................... 5,541 8,067 10,683
Less net paid losses and loss expenses...................... 3,458 3,800 4,212
------- ------- -------
Net increase in unpaid losses and loss expenses............. 2,083 4,267 6,471
Net unpaid losses and loss expenses at end of year.......... 34,850 32,767 28,500
Unpaid losses and loss expenses recoverable at end of
year...................................................... 43,211 37,905 32,584
------- ------- -------
Gross unpaid losses and loss expenses at end of year........ $78,061 $70,672 $61,084
======= ======= =======
</TABLE>
Incurred but not reported (IBNR) losses, net of reinsurance, included in the
above table was $17.0 million in 1998, $16.6 million in 1997 and $13.4 million
in 1996. Unpaid losses recoverable are net of potential uncollectable amounts.
As of December 31, 1998 and 1997, the Company had approximately 400 and 380
open claim files, respectively, for potential asbestos exposures and 760 and 840
open claim files, respectively, for potential environmental exposures.
Approximately 51% and 49% of the open claim files for 1998 and 1997,
respectively, are due to precautionary claim notices. Precautionary claim
notices are submitted by the ceding companies in order to preserve their right
to receive coverage under the reinsurance contract. Such notices do not contain
an incurred loss amount to the Company.
The Company believes it has made reasonable provision for its asbestos and
environmental exposures and is unaware of any specific issues which would
materially affect its estimate for losses and loss expenses. The estimation of
loss and loss expense liabilities for asbestos and environmental exposures is
subject to much greater uncertainty than is normally associated with the
establishment of liabilities for certain other exposures due to several factors,
including: i) uncertain legal interpretation and application of insurance and
reinsurance coverage and liability; ii) the lack of reliability of available
historical claims data as an indicator of future claims development; iii) an
uncertain political climate which may impact, among other areas, the nature and
amount of costs for remediating waste sites; and iv) the potential of insurers
and reinsurers to reach agreements in order to avoid further significant legal
costs. Due to the potential significance of these uncertainties, the Company
believes that no meaningful range of loss and loss expense liabilities beyond
recorded reserves can be established. As these uncertainties are resolved,
additional reserve provisions, which could be material in amount, may be
necessary.
8. REINSURANCE
The Company, through its subsidiaries, utilizes reinsurance and retrocession
agreements principally to increase aggregate capacity and to reduce the risk of
loss on business assumed. The Company's reinsurance
60
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. DOLLARS IN THOUSANDS)
8. REINSURANCE (CONTINUED)
and retrocession agreements provide for recovery of a portion of loss and loss
expenses from reinsurers and reinsurance recoverables are recorded as assets.
The Company is liable if the reinsurers are unable to satisfy their obligations
under the agreements.
A quota share reinsurance policy exists with several U.S. reinsurers
covering general liability insurance risks only. Under the terms of this
reinsurance, the Company ceded either 20% or 25% of each risk depending upon the
underlying limit written. The maximum amount recoverable from the reinsurers is
the ceded percentage of the original policy limit on a per occurrence basis,
with an annual aggregate of 225% of the total premium ceded.
There are a limited amount of retrocession agreements in place for the
Company's short tail reinsurance business assumed. Coverages in place have
related to common account reinsurance on proportional contracts written and
"high level" property catastrophe excess of loss protection. For the long tail
casualty reinsurance business written, several reinsurance policies are in place
to limit the Company's retention on any one claim and also for multiple claims
arising from two or more risks in a single occurrence or event.
The Company's Lloyd's syndicates have traditionally purchased a significant
amount of reinsurance to protect against extraordinary loss and/or loss
involving one or more of the lines of business written. Reinsurance is purchased
on an excess of loss and quota share basis.
The effect of reinsurance and retrocessional activity on premiums written
and earned is shown below:
<TABLE>
<CAPTION>
PREMIUMS WRITTEN PREMIUMS EARNED
YEAR ENDED DECEMBER 31, YEAR ENDED DECEMBER 31,
----------------------------------- ------------------------------------
1998 1997 1996 1998 1997 1996
---------- --------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Direct......................... 779,551 517,773 658,369 672,871 537,070 561,948
Assumed........................ 863,988 617,612 788,103 926,730 783,116 702,079
Ceded.......................... (319,275) (254,940) (279,604) (275,310) (205,428) (225,384)
---------- --------- ---------- ---------- ---------- ----------
Net............................ $1,324,264 $ 880,445 $1,166,868 $1,324,291 $1,114,758 $1,038,643
========== ========= ========== ========== ========== ==========
</TABLE>
The Company recorded reinsurance recoveries on loss and loss expenses
incurred of $294.0 million, $166.3 million and $184.5 million for the years
ended December 31, 1998, 1997 and 1996, respectively.
The Company has the following reinsurance balances recorded at December 31,
1998 and 1997:
<TABLE>
<CAPTION>
1998 1997
-------- --------
<S> <C> <C>
Unpaid losses and loss expenses recoverable................. $593,960 $363,716
Reinsurance balances receivable............................. 124,771 10,646
Reinsurance balances payable................................ $183,660 $102,753
</TABLE>
Increases in all of the above balances in 1998 over 1997 is primarily due to
the acquisition of Mid Ocean. The Company is the beneficiary of letters of
credit, trust accounts and funds withheld in the aggregate amount of $130
million at December 31, 1998, collateralizing reinsurance recoverables with
respect to certain retrocessionnaires.
61
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. DOLLARS IN THOUSANDS)
9. LONG-TERM DEBT AND FINANCING ARRANGEMENTS
As at December 31, 1998, the Company and its subsidiaries had bank and loan
facilities available from a variety of resources including commercial banks
totaling $2.24 billion of which $613.9 million was outstanding. In addition
$348.9 million of letters of credit were outstanding, most of which were
collateralized by the Company's investment portfolio, primarily supporting U.S.
non admitted business and the Company's Lloyd's capital requirements. The
financing structure at December 31, 1998 was as follows:
<TABLE>
<CAPTION>
FACILITY COMMITMENT IN USE/OUTSTANDING
- -------- ---------- ------------------
<S> <C> <C>
DEBT:
Company term note........................................... $ 11.0 $ 11.0
3 facilities of 364 day Revolvers--total.................... 700.0 113.0
2 facilities of 5 year Revolvers--total..................... 350.0 190.0
NAC Re 7.15% Senior Notes due 2005.......................... 100.0 99.9
NAC Re 8% Senior Notes due 1999............................. 100.0 100.0
NAC Re 5.25% Convertible Subordinated Debentures due 2002... 100.0 100.0
-------- ------
$1,361.0 $613.9
======== ======
LETTERS OF CREDIT:
3 facilities--total $ 876.0 $348.9
======== ======
</TABLE>
The one-year facilities are provided by two syndicates of banks where the
borrowings are unsecured, and by a U.S. bank where the borrowings are
collateralized and guaranteed by a subsidiary of the Company. Amounts borrowed
and outstanding at December 31, 1998 under these facilities were used primarily
to fund the Company's U.S. operations. The weighted average interest rate on the
funds borrowed during 1998 was approximately 5.9%.
The two five year facilities are provided by two syndicates of banks and
borrowings are unsecured. The amount of $190 million outstanding at
December 31, 1998 relates to the balance remaining from $300 million borrowed to
finance the cash option election available to shareholders in connection with
the Mid Ocean acquisition in August 1998. The weighted average interest rate on
funds borrowed during 1998 was approximately 5.7%
In late 1995, NAC Re issued $100 million of 7.15% Senior Notes due
November 15, 2005 through a public offering at a price of $99.9 million.
NAC Re's $100 million of 5.25% Convertible Subordinated Debentures due
December 15, 2002, were issued in December 1992 through a private offering. The
Debentures were called in June 1999 and converted to approximately 1.8 million
of the Company's shares.
NAC Re's $100 million of 8% Senior Notes due June 15, 1999 were issued in
June 1992 through a public offering. These Notes were repaid in June 1999
through additional borrowings and internal funds.
Total pre tax interest expense on the borrowings described above was
$33.4 million, $29.6 million and $22.3 million for the years ended December 31,
1998, 1997 and 1996 respectively. Associated with the Company's bank and loan
commitments are various loan covenants with which the Company was in compliance.
The Company has three letter of credit facilities available, two from a
syndicate of banks and one from a U.K. bank. These facilities are used to
collateralize certain reinsured's premium and unpaid loss reserves with the
Company and for Lloyd's capital requirements of the Company's corporate
syndicates. The letters of credit outstanding at December 31, 1998 of
$348.9 million were collateralized against the Company's investment portfolio.
62
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. DOLLARS IN THOUSANDS)
10. COMMITMENTS AND CONTINGENCIES
A) FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Company invests in derivative instruments, such as foreign currency
forward contracts, and futures for purposes other than trading. These derivative
instruments are used for foreign currency exposure management and to obtain
exposure to specific financial markets.
I) FOREIGN CURRENCY EXPOSURE MANAGEMENT
The Company uses foreign exchange contracts to manage its exposure to the
effects of fluctuating foreign currencies on the value of its foreign currency
fixed maturities and equity investments on an overlay basis. The fair value of
the Company's foreign currency denominated investments as at December 31, 1998
was $36.3 million. These contracts are not designated as specific hedges for
financial reporting purposes and, therefore, realized and unrealized gains and
losses recognized on them are recorded as a component of net realized gains and
losses in the period in which they occur. These contracts generally have
maturities of three months or less. In addition, where the Company's investment
managers are of the opinion that potential gains exist in a particular currency,
then a forward contract will not be entered into. At December 31, 1998, forward
foreign exchange contracts with notional principal amounts totaling
$322.4 million were outstanding. The fair value of these contracts as at
December 31,1998, was $316.2 million with unrealized losses of $6.2 million.
Gains of $17.0 million were realized during the year.
In addition, the Company also enters into foreign exchange contracts to buy
and sell foreign currencies in the course of trading its foreign currency
investments. These contracts are not designated as specific hedges for financial
reporting purposes, and generally have maturities of two weeks or less. As such,
any realized or unrealized gains or losses are recorded in income in the period
in which they occur. At December 31, 1998, the value of such contracts
outstanding was not material.
The Company attempts to hedge directly the foreign currency exposure of a
portion of its foreign currency fixed maturity investments using forward foreign
exchange contracts that generally have maturities of three months or less, and
which are rolled over to provide continuing coverage for as long as the
investments are held. Where an investment is sold, the related foreign exchange
sale contract is closed by entering into an offsetting purchase contract. At
December 31, 1998, the Company had, as hedges, foreign contracts for the sale of
$37.5 million and the purchase of $0.1 million of foreign currencies at fixed
rates, primarily New Zealand dollars (42% of net contract value), Norwegian
Kroner (34%) and British pounds (11%). The market value of foreign currency
fixed maturities held by the Company as at December 31, 1998 was $36.3 million.
Unrealized foreign exchange gains or losses on foreign exchange contracts
hedging non-U.S. Dollar fixed maturity investments are deferred and included in
shareholders' equity. As at December 31, 1998, unrealized deferred losses
amounted to $1.3 million, and were offset by corresponding increases in the U.S.
dollar value of the investments. Realized gains and losses on the maturity of
these contracts are also deferred and included in shareholders' equity until the
corresponding investment is sold. As at December 31, 1998, realized deferred
losses amounted to $0.7 million.
The Company is exposed to credit risk in the event of non-performance by the
other parties to the forward contracts, however the Company does not anticipate
non-performance. The difference between
63
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. DOLLARS IN THOUSANDS)
10. COMMITMENTS AND CONTINGENCIES (CONTINUED)
the notional principal amounts and the associated market value is the Company's
maximum credit exposure.
II) FINANCIAL MARKET EXPOSURE
The Company also invests in a synthetic equity portfolio of S&P Index
futures with an exposure approximately equal in amount to the market value of
underlying assets held in this fund. As at December 31 1998, the portfolio held
$148.2 million in exposure to S&P 500 Index futures and underlying assets of
$149.6 million. The value of the futures is updated daily with the change
recorded in income as a realized gain or loss. For the year ended December 31,
1998, net realized gains from index futures totaled $23.2 million.
Derivative investments are also utilized to add value to the portfolio where
market inefficiencies are believed to exist. At December 31, 1998, bond and
stock index futures outstanding were $235.6 million, with underlying investments
having a market value of $2.1 billion. All managers are prohibited by the
Company's investment guidelines from leveraging their positions.
B) CONCENTRATIONS OF CREDIT RISK
The Company's investment portfolio is managed by external managers in
accordance with guidelines that have been tailored to meet specific investment
strategies, including standards of diversification which limit the allowable
holdings of any single issue. The Company did not have an aggregate investment
in a single entity, other than the U.S. government, in excess of 10% of
shareholders' equity at December 31, 1998.
C) OTHER INVESTMENTS
The Company has committed to invest in several limited partnerships as part
of its overall corporate strategy. The primary purpose of these partnerships is
to invest capital provided by the partners in various insurance and reinsurance
ventures. The Company had invested $33.3 million and $27.2 million as at
December 31, 1998 and 1997, respectively, with commitments to invest a further
$138.7 million over the next ten years. The Company received income from its
investments of $3.6 million and $4.3 million for the years ended December 31,
1998 and 1997, respectively. The Company continually reviews the performance of
the partnerships to ensure there is no decrease in the values of its
investments. The Company is a limited partner and, as such, does not actively
participate in the management of the partnerships.
D) PROPERTIES
The Company rents space for its principal executive offices under leases
which expire up to 2016. Total rent expense for the years ended December 31,
1998, 1997 and 1996 was approximately $9 million, $7 million and $6 million,
respectively. Future minimum rental commitments under existing leases are
expected to be approximately $9 million annually. In 1997 the Company acquired
commercial real estate in Hamilton, Bermuda for the purpose of securing
long-term office space to meet its anticipated needs. The Company is in the
process of developing this property and constructing its worldwide headquarters.
The total cost of the development, including the land, is expected to be
approximately $110 million, of which $25 million has been spent to December 31,
1998. It is estimated that the development will be completed
64
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. DOLLARS IN THOUSANDS)
10. COMMITMENTS AND CONTINGENCIES (CONTINUED)
sometime in 2001. Upon completion of the development, it is expected that the
Company's rental commitments will be reduced.
11. SHARE CAPITAL
(A) AUTHORIZED AND ISSUED
The authorized share capital is 999,990,000 ordinary shares of a par value
of $0.01 each. Holders of Class A shares are entitled to one vote for each share
held while class B shares are not entitled to vote. In all other respects,
Class A and B shares rank PARI PASSU.
The following table is a summary of shares issued and outstanding:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Balance--beginning of year....................... 101,282 104,192 112,222
Exercise of options.............................. 425 503 627
Issuance of restricted shares.................... 289 173 478
Repurchase of shares............................. (3,443) (3,586) (9,135)
Issuance of Class A shares....................... 27,076 -- --
Issuance of Class B shares....................... 3,116 -- --
------- ------- -------
Balance--end of year............................. 128,745 101,282 104,192
======= ======= =======
</TABLE>
The issuance of Class A shares was in exchange for Mid Ocean Limited shares
and Financial Security Assurance Holdings Ltd. shares. The issuance of Class B
shares was in exchange for the Mid Ocean Limited Class B and Class C shares.
(B) SHARE REPURCHASES
The Company has had several stock repurchase plans in the past as part of
its capital management. In June 1999, the Board of Directors rescinded the
Company's share repurchase plans.
(C) STOCK PLANS
The Company's executive stock plan, the "1991 Performance Incentive
Program", provides for grants of non qualified or incentive stock options,
restricted stock awards and stock appreciation rights ("SARs"). The plan is
administered by the Company and Compensation Committee of the Board of
Directors. Stock options may be granted with or without SARs. Grant prices are
established at the fair market value of the Company's common stock at the date
of grant. Options and SARs have a life of 10 years and vest annually over three
years from date of grant.
Restricted stock awards issued under the 1991 Performance Incentive Program
plan vest over a five year period from the date of grant. These shares contained
certain restrictions, for said period, relating to among other things,
forfeiture in the event of termination of employment and transferability. As the
shares are issued, deferred compensation equivalent to the difference between
the issue price and the estimated fair market value on the date of the grant is
charged to shareholders' equity and subsequently amortized
65
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. DOLLARS IN THOUSANDS)
11. SHARE CAPITAL (CONTINUED)
over the five-year restriction period. Restricted stock issued under the plan
totaled 147,836 shares, 91,000 shares and 286,300 shares in 1998, 1997 and 1996,
respectively. Restricted stock awards granted by NAC Re prior to the merger
amounted to 23,700, 65,300 and 52,700 for the same respective periods. Vesting
for such shares generally occur over a six year period.
The Company also has stock plans in place for its non-employee directors.
The "Stock and Option Plan", issues non-qualified options to the
directors--4,000 shares at the commencement of their directorship and 2,000
shares each year thereafter. On December 3, 1997, 5,000 options were granted to
each director. All options vest immediately on grant date. Effective April 11,
1997 all options granted to Non-Employee Directors are granted under the 1991
Performance Incentive Program. Directors may also may make an irrevocable
election preceding the beginning of each fiscal year to defer cash compensation
that would otherwise be payable as his or her annual retainer in increments of
$5,000. The deferred payments are credited in the form of shares calculated by
dividing 110% of the deferred payment by the market value of the Company's stock
at the beginning of the fiscal year. Each anniversary thereafter, 20% of these
shares are distributed. Shares issued under the plan totaled 2,737, 3,048 and
4,048 in 1998, 1997 and 1996, respectively.
A second stock plan, intended to replace the directors' "Retirement Plan for
Non-Employee Directors", provides for the issuance of share units equal to the
amount that would have been credited to the Retirement Plan, divided by the
market price of the Company's stock on December 1 of each year. These units
receive dividends in the form of additional units equal to the cash value
divided by the market price on the payment date. During 1996 the directors could
elect to convert to this plan. Stock units totaling 5,531, 6,716 and 14,960 were
provided for in 1998, 1997 and 1996 respectively.
As a result of the merger with Mid Ocean Limited during August 1998, 791,573
Mid Ocean options were converted to options of XL Capital Ltd. These are
10 year options that generally vest over 3 years.
Following the merger with NAC Re, new option plans were created in the
Company to adopt the NAC Re plans. Under such plans, the Company had the
authority to grant up to 3,362,625 options at December 31, 1998, of which
1,189,500 options related to a plan implemented in 1997. Options generally have
a five or six year vesting schedule, with the majority expiring 10 years from
the date of grant; the remainder having no expiration. A stock plan is also
maintained for non-employee directors. Under such plan, NAC Re had the authority
to grant up to 343,125 options at December 31, 1998. Options expire 10 years
from the date of grant and are fully exercisable six months after their grant
date.
(D) FAS 123 PRO FORMA DISCLOSURE
The Company has adopted the disclosure-only provisions of Statement of
Financial Accounting Standard No. 123, "Accounting for Stock-Based
Compensation". Had the Company adopted the accounting provisions of SFAS
No. 123, compensation costs would have been determined based on the fair value
of
66
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. DOLLARS IN THOUSANDS)
11. SHARE CAPITAL (CONTINUED)
the stock option awards granted in 1998, 1997 and 1996, and net income and
earnings per share would have been reduced to the pro-forma amounts indicated
below:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Net income--as reported....................... $656,330 $809,029 $516,471
Net income--pro-forma......................... $635,239 $798,140 $511,660
Basic earnings per share--as reported......... $5.86 $7.95 $4.81
Basic earnings per share--pro-forma........... $5.67 $7.85 $4.77
Diluted earnings per share--as reported....... $5.68 $7.74 $4.73
Diluted earnings per share--pro-forma......... $5.47 $7.60 $4.66
</TABLE>
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model with the following weighted average
assumptions:
<TABLE>
<CAPTION>
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Dividend yield................................ 1.81% 1.89% 1.85%
Risk free interest rate....................... 4.76% 5.51% 5.36%
Expected volatility........................... 24.72% 23.49% 22.42%
Expected lives................................ 9.2 years 9.0 years 9.0 years
</TABLE>
Total stock based compensation recognized in net income was $5.8 million in
1998, $5.2 million in 1997 and $2.4 million in 1996.
(E) OPTIONS
Following is a summary of stock options and related activity:
<TABLE>
<CAPTION>
1998 1997 1996
-------------------- -------------------- --------------------
AVERAGE AVERAGE AVERAGE
NUMBER OF EXERCISE NUMBER OF EXERCISE NUMBER OF EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
--------- -------- --------- -------- --------- --------
<S> <C> <C> <C> <C> <C> <C>
Outstanding--beginning of year..... 5,744,063 $ 35.28 5,271,579 $29.27 3,920,192 $24.91
Granted............................ 1,749,885 $ 68.27 1,036,305 $57.20 1,695,385 $38.32
Granted--Mid Ocean conversion...... 791,573 $ 72.44 -- $ -- -- $ --
Exercised.......................... (425,251) $ 30.06 (506,891) $19.99 (277,242) $15.69
Canceled........................... (174,856) $ 40.12 (56,930) $40.97 (66,756) $36.63
--------- --------- ---------
Outstanding--end of year........... 7,685,414 $ 46.79 5,744,063 $35.28 5,271,579 $29.27
Options exercisable................ 4,288,434 3,043,676 2,495,345
========= ========= =========
Options available for grant........ 2,455,190 * 4,082,135 * 4,073,265 *
========= ========= =========
</TABLE>
- ------------------------
* Available for grant includes shares which may be granted on either stock
options or restricted stock.
67
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. DOLLARS IN THOUSANDS)
11. SHARE CAPITAL (CONTINUED)
(F) VOTING
XL's Articles of Association restrict the voting power of any person to less
than 10% of total voting power.
(G) SHARE RIGHTS PLAN
Rights to purchase Ordinary Shares were distributed as a dividend at the
rate of one Right for each outstanding Ordinary Share held of record as of the
close of business on October 31, 1998. Each Right entitles holders of XL
Ordinary Shares to buy one ordinary share at an exercise price of $350.00. The
Rights would be exercisable, and would detach from the Ordinary Shares, only if
a person or group were to acquire 20 percent or more of XL's outstanding
Ordinary Shares, or were to announce a tender or exchange offer that, if
consummated, would result in a person or group beneficially owning 20 percent or
more of XL's Ordinary Shares. Upon a person or group without prior approval of
the Board acquiring 20 percent or more of XL's Ordinary Shares, each Right would
entitle the holder (other than such an acquiring person or group) to purchase XL
Ordinary Shares (or, in certain circumstances, Ordinary Shares of the acquiring
person) with a value of twice the Rights exercise price upon payment of the
Rights exercise price. XL will be entitled to redeem the Rights at $0.01 per
Right at any time until the close of business on the tenth day after the Rights
become exercisable. The Rights will expire at the close of business on
September 30, 2008, and do not initially have a fair value. The Company has
initially reserved 119,073,878 Ordinary Shares being authorized and unissued for
issuance upon exercise of the Rights.
12. RETIREMENT PLANS
The Company maintains both defined contribution and defined benefit
retirement plans, which vary for each subsidiary. Plan assets are invested
principally in equity securities and fixed maturities
Through XLI and XLMORe in Bermuda, a qualified defined contribution plan
exists which is managed externally and whereby employees and the Company
contribute a certain percentage of the employee's gross salary into the plan
each month. The Company's contribution generally vests over 5 years.
At NAC Re, a qualified non-contributory defined benefit pension plan exists
to cover substantially all its U.S. employees, the "NAC Re defined benefit
plan". Benefits are based on years of service and compensation, as defined in
the plan, during the highest consecutive three years of the employee's last ten
years of employment.
Under the NAC Re defined benefit plan, the Company's policy is to make
annual contributions to the plan that are deductible for federal income tax
purposes and that meet the minimum funding standards required by law. The
contribution level is determined by utilizing the entry age cost method and
different actuarial assumptions than those used for pension expense purposes.
This plan also includes a non-qualified supplemental defined benefit plan
designed to compensate individuals to the extent their benefits under the
Company's qualified plan are curtailed due to Internal Revenue Code limitations.
The projected benefit obligation, accumulated benefit obligation and fair
value of the assets for the NAC Re defined benefit plan with accumulated benefit
obligations in excess of the plan assets were $5.0 million, $2.5 million and $0,
respectively as of December 31, 1998 and $4.1 million, $2.1 million and $0 as of
December 31, 1997, respectively. The discount rates used in determining the
actuarial present value
68
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. DOLLARS IN THOUSANDS)
12. RETIREMENT PLANS (CONTINUED)
of benefit obligations were 6.5% and 6.75% for 1998 and 1997, respectively. The
rate of increase for future compensation levels was 5.5% for both 1998 and 1997.
The assumed rate of return on plan assets was 9.0% for 1998 and 8.5% for 1997.
NAC Re also maintain a qualified contributory defined contribution plan for
substantially all its U.S. employees and a qualified non contributory defined
contribution plan for all its U.K. employees.
The Company's expenses for its retirement plans is not material.
13. OTHER COMPREHENSIVE INCOME
In 1998, the Company adopted SFAS No. 130, "Reporting Comprehensive Income,"
which requires that a company classify items that meet the definition of
components of other comprehensive income in a financial statement and display
the accumulated balance of other comprehensive income in the equity section of
the statement of financial position. Comprehensive income includes all changes
in equity during a period resulting from transactions and other events from
non-owner sources. Reclassification of prior period financial statements is
required for comparative purposes.
The balances of each classification, net of deferred taxes, within
accumulated other comprehensive income is as follows:
<TABLE>
<CAPTION>
NET UNREALIZED FOREIGN CURRENCY
APPRECIATION ON TRANSLATION ACCUMULATED OTHER
INVESTMENTS ADJUSTMENTS COMPREHENSIVE INCOME
--------------- ---------------- --------------------
<S> <C> <C> <C>
YEAR ENDED DECEMBER 31, 1998
Beginning balance............................. $245,482 $5,989 $251,471
Current year change........................... (15,414) (872) (16,286)
-------- ------ --------
Ending balance................................ $230,068 $5,117 $235,185
======== ====== ========
YEAR ENDED DECEMBER 31, 1997
Beginning balance............................. $239,249 $8,377 $247,626
Current year change........................... 6,233 (2,388) 3,845
-------- ------ --------
Ending balance................................ $245,482 $5,989 $251,471
======== ====== ========
YEAR ENDED DECEMBER 31, 1996
Beginning balance............................. $295,446 $1,017 $296,463
Current year change........................... (56,197) 7,360 (48,837)
-------- ------ --------
Ending balance................................ $239,249 $8,377 $247,626
======== ====== ========
</TABLE>
69
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. DOLLARS IN THOUSANDS)
13. OTHER COMPREHENSIVE INCOME (CONTINUED)
The related tax effects allocated to each component of other comprehensive
income were as follows:
<TABLE>
<CAPTION>
BEFORE TAX TAX EXPENSE NET OF TAX
AMOUNT (BENEFIT) AMOUNT
---------- ----------- ----------
<S> <C> <C> <C>
YEAR ENDED DECEMBER 31, 1998
Unrealized gains (losses) on investments:
Unrealized gains arising during year...................... $196,512 $ 12,998 $183,514
Less reclassification adjustment for gains realized in
income.................................................. 211,204 12,276 198,928
-------- -------- --------
Net unrealized losses....................................... (14,692) 722 (15,414)
Foreign currency translation adjustments.................... (1,342) (470) (872)
-------- -------- --------
Other comprehensive income.................................. $(16,034) $ 252 $(16,286)
======== ======== ========
YEAR ENDED DECEMBER 31, 1997
Unrealized gains (losses) on investments:
Unrealized gains arising during year...................... $429,500 $ 27,291 $402,209
Less reclassification adjustment for gains realized in
income.................................................. 410,658 14,682 395,976
-------- -------- --------
Net unrealized gains (losses)............................... 18,842 12,609 6,233
Foreign currency translation adjustments.................... (3,674) (1,286) (2,388)
-------- -------- --------
Other comprehensive income.................................. $ 15,168 $ 11,323 $ 3,845
======== ======== ========
YEAR ENDED DECEMBER 31, 1996
Unrealized gains (losses) on investments:
Unrealized gains (losses) arising during year............. $116,382 $ 4,847 $111,535
Less reclassification adjustment for gains realized in
income.................................................. 174,593 6,861 167,732
-------- -------- --------
Net unrealized gains (losses)............................... (58,211) (2,014) (56,197)
Foreign currency translation adjustments.................... 11,323 3,963 7,360
-------- -------- --------
Other comprehensive income.................................. $(46,888) $ 1,949 $(48,837)
======== ======== ========
</TABLE>
14. CONTRIBUTED SURPLUS
Under the laws of the Cayman Islands, the use of XL's contributed surplus is
restricted to the issuance of fully paid shares (i.e. stock dividend or stock
split) and the payment of any premium on the redemption of ordinary shares.
15. DIVIDENDS
The following dividend information relates to the Company without inclusion
of the pooling effect with NAC Re:
In 1998, four regular quarterly dividends were paid, three of $0.40 per
share to shareholders of record at February 6, April 16 and July 15, and one of
$0.44 per share to shareholders of record at September 28.
70
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. DOLLARS IN THOUSANDS)
15. DIVIDENDS (CONTINUED)
In 1997, four regular quarterly dividends were paid, three of $0.32 per
share to shareholders of record at February 6, April 22 and July 11, and one of
$0.40 per share to shareholders of record at September 25.
In 1996, four regular quarterly dividends were paid, one of $0.20 per share
to shareholders of record at February 2, and three of $0.25 per share to
shareholders of record at April 15, July 12 and October 11.
16. TAXATION
Under current Cayman Islands law, the Company is not subject to pay any
taxes in the Cayman Islands on either income or capital gains. The Company have
received an undertaking that in the event of any such taxes being imposed, the
Company will be exempted from Cayman Islands income or capital gains until
June 2018.
Bermuda presently imposes no income, withholding or capital gains taxes and
XL and its Bermuda subsidiaries are exempted until March 2016 from any such
future taxes pursuant to the Bermuda Exempted Undertakings Tax Protection Act
1966, and Amended Act 1987.
XL Investments (Barbados), Inc. qualifies as an exempted company under the
provisions of the International Business Companies Act 1991-24 and as such is
subject to a maximum tax rate in Barbados of 2.50%.
XLE has been approved to carry on business in the International Services
Centre in Dublin. Under Section 39 of the Finance Act 1990, XLE is entitled to
benefit from a 10% tax rate on profits (including investment income) until the
year 2005.
Brockbank, NAC Re International and XLMORe's London branch office are
subject to United Kingdom corporation taxes. Profits of XLMORe's Singapore
branch office are subject to Singapore corporation taxes. The German subsidiary
of XLMORe is subject to taxation in Germany.
The Company's U.S. subsidiaries are subject to Federal, State and local
corporate income taxes and other taxes applicable to U.S. corporations. The
provision for federal income taxes has been determined on the basis of a tax
return for each of the Company's U.S. subsidiaries. Should the U.S. subsidiaries
pay a dividend to the parent, withholding taxes will apply.
The income tax provision in the consolidated statement of income gives
effect to the permanent differences between financial and taxable income as
applied for each relevant subsidiary. Due to the fact that the Company and
certain subsidiaries are not subject to direct U.S. income taxes and that
certain U.S. subsidiaries have tax-exempt income, the Company's effective income
tax rate for its U.S. operations is less than the statutory U.S. tax rate.
71
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. DOLLARS IN THOUSANDS)
16. TAXATION (CONTINUED)
An analysis of the Company's effective tax rate is as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------------
1998 1997 1996
---------------------- ---------------------- ----------------------
1998 % OF PRETAX 1997 % OF PRETAX 1996 % OF PRETAX
AMOUNT INCOME AMOUNT INCOME AMOUNT INCOME
-------- ----------- -------- ----------- -------- -----------
<S> <C> <C> <C> <C> <C> <C>
Income taxes computed on U.S.
operating income................... $ 41,259 35% $ 42,990 35% $ 31,163 35%
U.S. tax exempt investment income.... (19,183) (16%) (16,680) (14%) (12,272) (14%)
Other, net........................... (244) -- 843 -- (375) --
-------- ---- -------- ---- -------- ----
Tax expense on U.S. operating
income............................. 21,832 19% 27,153 21% 18,516 21%
---- ---- ----
Non U.S. taxes....................... 8,051 5,019 2,607
-------- -------- --------
Income taxes......................... $ 29,883 $ 32,172 $ 21,123
======== ======== ========
</TABLE>
Significant components of the provision for income taxes attributable to
operations were as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
CURRENT EXPENSE:
U.S....................................................... $10,490 $43,754 $19,879
Non U.S................................................... 14,680 11,745 6,032
------- ------- -------
Total current expense....................................... 25,170 55,499 25,911
------- ------- -------
DEFERRED EXPENSE (BENEFIT):
U.S....................................................... 4,729 (23,205) (4,845)
Non U.S................................................... (16) (122) 57
------- ------- -------
Total deferred expense (benefit)............................ 4,713 (23,327) (4,788)
------- ------- -------
TOTAL TAX EXPENSE........................................... $29,883 $32,172 $21,123
======= ======= =======
</TABLE>
The U.S. subsidiary's current U.S. taxable income is based on alternative
minimum taxable income. The current U.S. tax expense for the years ended
December 31, 1997 and 1996 was based on regular taxable income.
U.S. and Non U.S. taxes paid in the years ended December 31, 1998, 1997 and
1996 were approximately $31 million, $38 million and $24 million, respectively.
72
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. DOLLARS IN THOUSANDS)
16. TAXATION (CONTINUED)
Significant components of the Company's deferred tax assets and liabilities,
which principally relate to US subsidiaries, as of December 31, 1998 and 1997
were as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1998 1997
---------- ----------
<S> <C> <C>
DEFERRED TAX ASSET:
Net unpaid loss reserve discount.......................... $ 84,008 $ 87,704
Net unearned premiums..................................... 19,888 18,854
Compensation liabilities.................................. 6,978 6,195
Other..................................................... 3,331 2,631
-------- --------
Deferred tax asset.......................................... 114,205 115,384
-------- --------
DEFERRED TAX LIABILITY:
Deferred policy acquisition costs......................... $ 33,896 $ 32,375
Unrealized appreciation on investments.................... 31,050 29,616
Currency translation adjustments.......................... 2,755 3,225
Other..................................................... 9,023 7,522
-------- --------
Deferred tax liability...................................... 76,724 72,738
-------- --------
NET DEFERRED TAX ASSET...................................... $ 37,481 $ 42,646
======== ========
</TABLE>
Shareholders' equity at December 31, 1998 and 1997 reflects tax benefits of
$5.6 million and $4.5 million, respectively, related to compensation expense
deductions for stock options exercised for one of the Company's U.S.
subsidiaries.
17. STATUTORY FINANCIAL DATA
The Company's ability to pay dividends is subject to certain regulatory
restrictions on the payment of dividends by its subsidiaries. The Company relies
primarily on cash dividends from XLI and Mid Ocean. The payment of such
dividends is restricted by applicable laws of Bermuda, Ireland, U.S. and United
Kingdom, including those promulgated by the Society of Lloyd's.
BERMUDA
Under The Insurance Act, 1978, (as amended by the Insurance Act Amendment
1995) amendments thereto and related regulations of Bermuda (the "Act"), XLI and
XLMORe are required to prepare statutory financial statements and to file in
Bermuda a statutory financial return. The Act also requires these companies to
maintain certain measures of solvency and liquidity during the year.
73
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. DOLLARS IN THOUSANDS)
17. STATUTORY FINANCIAL DATA (CONTINUED)
XLI's and XLMORe's statutory capital and surplus, statutory net income and
the minimum statutory capital and surplus required by the Act were as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------
X.LI. XLMORE
-------------------------------- --------------------------------
1998 1997 1996 1998 1997 1996
---------- -------- -------- ---------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Statutory net income................ $ 309,244 $189,281 $367,322 $ 108,290 $ 57,995 $ 21,398
========== ======== ======== ========== ======== ========
Statutory capital and surplus....... $1,255,284 $882,366 $872,586 $1,966,200 $512,637 $271,398
========== ======== ======== ========== ======== ========
Minimum statutory capital and
surplus required by the Act....... $ 307,205 $310,240 $302,089 $ 100,000 $100,000 $100,000
========== ======== ======== ========== ======== ========
</TABLE>
The primary difference between statutory net income and statutory capital
and surplus for the Company's subsidiaries, as shown above, and net income and
shareholder's equity presented in accordance with generally accepted accounting
principles are deferred acquisition costs.
Under the Act, XLI and XLMORe are classified as a Class 4 insurer and
reinsurer, respectively. Therefore they are restricted to the payment of
dividends in any one financial year of 25% of the prior year's statutory capital
and surplus, unless their directors attest that such dividends will not cause
the company to fail to meet its relevant statutory requirements. XLI and XLMORe
have not been affected by this. XLI could legally have paid dividends in the
amount of approximately $1.8 billion, $1.5 billion and $1.1 billion at
November 30, 1998, 1997 and 1996, respectively. XLMORe could legally have paid
dividends in the amount of approximately $1.3 billion, $403.4 million and
$169.5 million at November 30, 1998, 1997 and 1996, respectively.
REPUBLIC OF IRELAND
XLE is permitted to cover risks throughout the European Community (subject
to certain restrictions) pursuant to the "Third Directive" relating to non-life
insurance. Its head office is in the Republic of Ireland and it is subject to
regulation under Irish regulatory authority. The principal legislation and
regulations governing the insurance activities of Irish insurance companies are
the Insurance Acts 1909 to 1990 (the "Irish Acts") and a comprehensive network
of regulations and statutory provisions empowering the making of regulations of
which the most relevant are the European Communities (Non-Life Insurance)
Regulations, 1976, the European Communities (Non-Life Insurance Accounts)
Regulations, 1995, the European Communities (Non-Life Insurance) Framework
Regulations, 1994 and related administrative rules (the "Irish Regulations".)
XLE's insurance activities are subject to extensive regulation in the
Republic of Ireland, principally under the Irish Acts and Irish Regulations,
which impose on insurers headquartered in the Republic of Ireland minimum
solvency and reserve standards and auditing and reporting requirements and grant
to the Minister for Enterprise and Employment (the"Irish Minister") wide powers
to supervise, investigate and intervene in the affairs of such insurers. The
Irish Minister's powers and functions are exercised through the medium of the
Department of Enterprise and Employment.
74
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. DOLLARS IN THOUSANDS)
17. STATUTORY FINANCIAL DATA (CONTINUED)
UNITED STATES
The Company's U.S. insurance subsidiaries are subject to regulatory
oversight under the insurance statutes and regulations of the jurisdictions in
which they conduct business.
Consolidated statutory net income and surplus of NAC Reinsurance Corporation
("NAC"), as reported to the insurance regulatory authorities, differs in certain
respects from the amounts as prepared in accordance with GAAP. The main
differences between domestic statutory net income and GAAP income relates to
deferred acquisition costs and deferred income taxes. The main differences
between statutory surplus and shareholders' equity, in addition to deferred
acquisition costs and deferred income tax net assets, are intangible assets,
unrealized appreciation on investments, and any unauthorized/ authorized
reinsurance charges. The following table shows domestic statutory net income and
domestic GAAP net income and consolidated statutory surplus and consolidated
shareholders' equity of NAC.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
NET INCOME:
Domestic statutory net income............................... $101,862 $ 70,292 $ 59,827
-------- -------- --------
Domestic GAAP net income.................................... $ 98,586 $ 99,692 $ 78,860
-------- -------- --------
SHAREHOLDERS' EQUITY:
Consolidated statutory surplus.............................. $737,114 $702,222 $663,867
-------- -------- --------
Investment in subsidiaries, GAAP............................ $992,310 $934,124 $825,283
-------- -------- --------
</TABLE>
NAC is subject to New York insurance law, which imposes certain restrictions
on the payment of cash dividends and tax reimbursements. Generally, NAC may pay
cash dividends only out of statutory earned surplus which was $231.9 million at
December 31, 1998. However, the maximum amount of dividends that may be paid in
any twelve- month period without the prior approval of the New York Insurance
Department is the lesser of net investment income or 10% of statutory surplus as
such terms are defined in the New York insurance law. The maximum amount NAC
could pay without such regulatory approval, based on 10% of statutory surplus as
of December 31, 1998 is approximately $73.7 million.
Brockbank, via Lloyd's, is a licensed insurer in the states of Illinois,
Kentucky and the U.S Virgin Islands ("USVI"). It is also an eligible surplus
lines writer in all states other than Kentucky and USVI, and an accredited
reinsurer in every state other than Michigan. Brockbank Insurance
Services, Inc., is a California licensed surplus and specialty lines broker.
The insurance laws of each state of the United States and of many foreign
countries regulate the sale of insurance within their jurisdiction by alien
insurers, such as XLI and XLMORe. The Company believes it is not in violation of
the insurance laws of any state in the U.S or any foreign country. From time to
time, various proposals for federal legislation within the United States have
been circulated which could require the Company to, amongst other things,
register as a surplus lines insurer. The Company believes that generally it
could meet and comply with the requirements to be registered as a surplus lines
insurer and such compliance would not have a material impact on the ability of
the Company to conduct its business. There can be no assurances, however, that
the activities of the Company will not be challenged in the
75
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. DOLLARS IN THOUSANDS)
17. STATUTORY FINANCIAL DATA (CONTINUED)
future or that the Company will be able to successfully defend against such
challenges or that legislation will not be enacted that will affect the
Company's ability to conduct its business.
UNITED KINGDOM
The United Kingdom Financial Services Authority ("UK FSA") regulates
reinsurance entities that are "effecting and carrying on" insurance business in
the United Kingdom. Both XLMORe, through its London branch and NAC Re through
its London subsidiary, "effect and carry on" business in the United Kingdom and
are therefore regulated by the UK FSA.
LLOYD'S
As a result of the Company's ownership of Brockbank and Denham, the Company,
Brockbank and Denham are subject to the regulatory jurisdiction of the Council
of Lloyd's (the "Council"). Unlike other financial markets in the UK, Lloyd's is
not subject to direct UK government regulation through The Financial Services
Act of 1986 but, instead, is self regulating by virtue of the Lloyd's Act of
1982 through the bye-laws, regulations and codes of conduct written by the
Council, which governs the market. Under the Council, there are two boards, the
Market Board and the Regulatory Board. The former is led by working members of
the Council and is responsible for strategy and the provision of services such
as premium and claims handling, accounting and policy signing. The Regulatory
Board is responsible for the regulation of the market, compliance and the
protection of policyholders and capital providers. Under the regulations, the
approval of the Council has to be obtained before any person can be a "major
shareholder" or "controller" of a corporate Name or managing agency. The Company
has been approved as both a "major shareholder" and a "controller" of its
corporate Names (the "CCVs") and managing agencies.
A person would be viewed by Lloyd's as a "major shareholder" of the CCVs if
such person owns 15% or more of the Company's outstanding capital stock and as a
"controller" if it owns 30% of more of the Company's outstanding capital stock.
Therefore, any person that becomes the owner of 15% or more of the Company's
stock may be required to deliver a declaration and undertaking to Lloyd's, in
the form prescribed by Lloyd's, unless Lloyd's exempts such person from this
requirement.
As a "controller", the Company is required to give certain undertakings,
directed principally towards ensuring that there is no direct interference in
the conduct of the business of the relevant managing agency, but there are no
provisions in the Lloyd's Act of 1982, the bye-laws or the regulations which
provide for any liabilities of the CCVs or the Brockbank group as a whole to be
met by the Company. In addition, a managing agency is required to comply with
various capital and solvency requirements and to submit to regular monitoring
and compliance procedures. The CCVs, as corporate members of Lloyd's are each
required to commit a specified amount approximately equal to 50% of their
underwriting capacity on the syndicates to support its underwriting on those
syndicates.
The Lloyd's Act of 1982 generally restricts certain direct or indirect
equity cross-ownership between a Lloyd's broker and a Lloyd's managing agent.
OTHER REGULATION
The Company is subject to regulation in Australia, Singapore, Madrid, South
America and Germany as a result of its representative offices and branches in
such jurisdictions.
76
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. DOLLARS IN THOUSANDS EXCEPT SHARE AND PER SHARE AMOUNTS)
18. EARNINGS PER SHARE
The following table sets forth the computation of the basic and diluted
earnings per share:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31:
------------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
BASIC EARNINGS PER SHARE:
Net income.................................................. $656,330 $809,029 $516,471
Weighted average ordinary shares outstanding................ 112,034 101,708 107,339
Basic earnings per share.................................... $ 5.86 $ 7.95 $ 4.81
======== ======== ========
DILUTED EARNINGS PER SHARE:
Net income.................................................. $656,330 $809,029 $516,471
Add back after-tax interest on convertible debentures....... 3,504 3,504 3,504
-------- -------- --------
Adjusted net income......................................... $659,834 $812,533 $519,975
-------- -------- --------
Weighted average ordinary shares outstanding--basic......... 112,034 101,708 107,339
Average stock options outstanding (1)....................... 2,152 1,277 549
Assumed conversion of convertible debentures (2)............ 2,020 2,020 2,020
-------- -------- --------
Weighted average ordinary shares outstanding--diluted....... 116,206 105,005 109,908
-------- -------- --------
Diluted earnings per share.................................. $ 5.68 $ 7.74 $ 4.73
======== ======== ========
</TABLE>
- ------------------------
(1) Net of shares repurchased under the treasury stock method.
(2) Reflects the assumed conversion of the NAC Re 5.25% Convertible Subordinated
Debentures due 2002.
19. SUBSEQUENT EVENTS
In March 1999, the Company acquired a passive minority investment in
Highfields Capital Management LP, a global equity investment firm.
In June 1999, the Company acquired ECS, Inc. ("ECS"), an underwriting
manager headquartered in Exton, Pennsylvania which specializes in environmental
insurance coverages and risk management services. ECS placed approximately
$200 million of gross premiums written with unaffiliated carriers in 1998. XL
intends, commencing January 2000, to have ECS originate and underwrite policies
on behalf of the Company's insurance and reinsurance subsidiaries.
In June 1999, the Company completed the acquisition of Intercargo
Corporation ("Intercargo"). Intercargo is headquartered in Schaumburg, Illinois
and through its subsidiaries underwrites specialty insurance products for
Companies engaged in international trade, including U.S. Customs bonds and
marine cargo insurance.
77
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. DOLLARS IN THOUSANDS EXCEPT SHARE AND PER SHARE AMOUNTS)
The Intercargo and ECS acquisitions are being accounted for under the
purchase method of accounting. The combined purchase price was $222.8 million
and the resulting goodwill is being amortized over 20 years.
In July 1999, the Company signed a joint venture agreement with Les
Mutuelles du Mans Assurances Group to form a new French reinsurance company, Le
Mans Re. The transaction is subject to satisfaction of certain conditions,
including the receipt of regulatory approvals. The Company has acquired a 49%
shareholding in the new company. The transaction was completed in November 1999.
In August 1999, the Company made a minority equity investment in MKP Capital
Management, a New York based fixed income investment manager specializing in
mortgage-backed securities.
In the fourth quarter of 1999, Brockbank sold its two motor insurance
businesses, Admiral and Zenith. The Company expects there to be decreases in
premiums, fee income and certain costs. The Company does not expect the overall
profitability of its Lloyd's operations to be materially affected by such sales.
20. UNAUDITED QUARTERLY FINANCIAL DATA
The following is a summary of the unaudited quarterly financial data for
1998 and 1997 based upon the Company's amended year end of December 31 and the
pooling adjustment with NAC Re:
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
-------- -------- -------- --------
<S> <C> <C> <C> <C>
1998
Net premiums earned............................... $274,149 $264,568 $384,136 $401,438
Net investment income............................. 92,923 87,183 111,320 125,864
Net realized gains on investments................. 77,349 58,400 28,476 46,979
Equity in net income (loss) of affiliates......... 15,501 20,721 17,451 (3,381)
Fee and other income.............................. 4,172 1,437 8,567 8,149
-------- -------- -------- --------
Total revenues.................................... $464,094 $432,309 $549,950 $579,049
======== ======== ======== ========
Income before income tax expense.................. $192,886 $170,971 $149,004 $173,352
======== ======== ======== ========
Net income........................................ $186,301 $165,422 $140,271 $164,336
======== ======== ======== ========
Net income per share and share
equivalent--basic............................... $ 1.84 $ 1.63 $ 1.20 $ 1.28
======== ======== ======== ========
Net income per share and share
equivalent--diluted............................. $ 1.78 $ 1.58 $ 1.17 $ 1.25
======== ======== ======== ========
1997
Net premiums earned............................... $248,903 $268,045 $266,437 $331,373
Net investment income............................. 81,258 84,445 87,795 91,618
Realized gains on investments..................... 25,248 223,783 93,692 67,935
Equity in net income of affiliates................ 13,112 15,452 16,394 20,001
-------- -------- -------- --------
Total revenues.................................... $368,521 $591,725 $464,318 $510,927
======== ======== ======== ========
Income before income tax expense.................. $123,116 $325,555 $194,992 $197,538
======== ======== ======== ========
Net income........................................ $115,773 $316,021 $188,578 $188,657
======== ======== ======== ========
Net income per share and share
equivalent--basic............................... $ 1.12 $ 3.12 $ 1.86 $ 1.86
======== ======== ======== ========
Net income per share and share
equivalent--diluted............................. $ 1.10 $ 3.04 $ 1.81 $ 1.82
======== ======== ======== ========
</TABLE>
78
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. DOLLARS IN THOUSANDS EXCEPT SHARE AND PER SHARE AMOUNTS)
21. UNAUDITED CONDENSED PRO FORMA FINANCIAL INFORMATION
Unaudited condensed pro forma financial information shown below relates to
the Company's acquisition of Mid Ocean Limited in August 1998 and is based upon
the assumption that Mid Ocean Limited had always been a part of the Company's
operations.
<TABLE>
<CAPTION>
PRO FORMA PRO FORMA
1998 1997
---------- ----------
<S> <C> <C>
Net premiums earned.................................. $1,588,781 $1,607,768
Net investment income................................ 494,389 443,031
Net realized gains................................... 260,608 378,213
Equity in earnings of affiliates..................... (1,897) 3,748
Fee and other income................................. 28,006 24,710
---------- ----------
Total revenues..................................... 2,369,887 2,457,470
---------- ----------
Losses and loss expenses............................. 921,018 966,909
Acquisition costs and operating expenses............. 514,877 450,893
Interest expense..................................... 44,839 46,311
Amortization of intangible assets.................... 45,464 37,560
---------- ----------
Total expenses..................................... 1,526,198 1,501,673
---------- ----------
Income before minority interest and income tax
expense............................................ 843,689 955,797
Minority interest and income tax..................... 34,535 45,653
---------- ----------
Net income......................................... $ 809,154 $ 910,144
---------- ----------
Net income per share
Basic.............................................. $ 6.33 $ 7.08
Diluted............................................ $ 6.13 $ 6.89
Weighted average shares outstanding (000's)
Basic.............................................. 127,883 128,550
Diluted............................................ 132,036 132,173
</TABLE>
79
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There have been no changes in nor any disagreements with accountants on
accounting and financial disclosure within the twenty-four months ending
December 31, 1998.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
This item is omitted because a definitive proxy statement which involves the
election of directors was filed with the Securities and Exchange Commission not
later than 120 days after the close of the fiscal year pursuant to
Regulation 14A, which proxy statement is incorporated by reference.
ITEM 11. EXECUTIVE COMPENSATION
This item is omitted because a definitive proxy statement which involves the
election of directors was filed with the Securities and Exchange Commission not
later than 120 days after the close of the fiscal year pursuant to
Regulation 14A, which proxy statement is incorporated by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
This item is omitted because a definitive proxy statement which involves the
election of directors was filed with the Securities and Exchange Commission not
later than 120 days after the close of the fiscal year pursuant to
Regulation 14A, which proxy statement is incorporated by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
This item is omitted because a definitive proxy statement which involves the
election of directors was filed with the Securities and Exchange Commission not
later than 120 days after the close of the fiscal year pursuant to
Regulation 14A, which proxy statement is incorporated by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Financial Statements, Financial Statement Schedules and Exhibits.
<TABLE>
<CAPTION>
PAGE
--------
<S> <C>
- --Report of PricewaterhouseCoopers LLP on Financial
Statements and Financial Statement Schedules.............. 84
- --Report of Ernst & Young LLP on Financial Statements and
Financial Statement Schedules............................. 85
</TABLE>
1. FINANCIAL STATEMENTS
Included in Part II--See Item 8 of this report.
80
<PAGE>
2. FINANCIAL STATEMENT SCHEDULES
Included in Part IV of this report:
<TABLE>
<CAPTION>
SCHEDULE
NUMBER PAGE
-------- --------
<S> <C> <C>
- --Consolidated Summary of Investments--Other than
Investments in Related Parties, as of December 31, 1998... I 62
- --Condensed Financial Information of Registrant, as of
December 31, 1998 and 1997 and for the years ended
December 31, 1998, 1997, and 1996......................... II 63
- --Reinsurance, for the years ended December 31, 1998, 1997
and 1996.................................................. IV 66
- --Supplementary Information Concerning Property/Casualty
Insurance Operations for the years ended December 31,
1998, 1997, and 1996...................................... VI 67
</TABLE>
Other Schedules have been omitted as they are not applicable to the Company.
3. EXHIBITS
<TABLE>
<C> <S>
3.1 Memorandum of Association, incorporated by reference to
Annex G to the Joint Proxy Statement of EXEL Limited and Mid
Ocean Limited dated July 2, 1998.
3.2 Articles of Association, incorporated by reference to Annex
G to the Joint Proxy Statement of EXEL limited and Mid Ocean
Limited dated July 2, 1998.
4.1 Rights Agreement, dated as of September 11, 1009 between the
Company and ChaseMellon Shareholder Services, L.L.C., as
Rights Agent, incorporated by reference to the Company's
Current Report on Form 8-K dated October 21, 1998.
10.1 Money Accumulation Savings Program, incorporated by
reference to Exhibit 10.15 to the Company's Registration
Statement on Form S-1 (No. 33-40533).
10.2 1991 Performance Incentive Program, incorporated by
reference to Exhibit 10.16 to the Company's Registration
Statement on Form S-1 (No. 33-40533).
10.3 1991 Management Incentive Plan, incorporated by reference to
Exhibit 10.17 to the Company's Registration Statement on
Form S-1 (No. 33-40533).
10.4 First Amendment to the 1991 Performance Incentive Program,
incorporated by reference to Exhibit 10.4 to the Company's
Annual Report on Form 10-K for the year ended November 30,
1996.
10.5 Retirement Plan for Non-employee Directors of XL Capital
Ltd, as amended, incorporated by reference to Exhibit 10.5
to the Company's Annual Report on Form 10-K for the year
ended November 30, 1996.
10.6.1 XL Capital Ltd Directors Stock and Option Plan, as amended,
incorporated by reference to Exhibit 10.6 to the Company's
Annual Report on Form 10-K for the year ended November 30,
1996.
10.6.2 Fourth Amendment to EXEL Limited Directors Stock and Option
Plan, incorporated by reference to Exhibit 10.6.2 to the
Company's Annual Report on Form 10-K (No. 1-10804) for the
year ended November 30, 1998.
</TABLE>
81
<PAGE>
<TABLE>
<C> <S>
10.7 XL Capital Ltd Stock Plan for Nonemployee Directors,
incorporated by reference to Exhibit 10.6 to the Company's
Annual Report on Form 10-K for the year ended November 30,
1996.
10.8 (Intentionally omitted)
10.9.1 Mid Ocean Limited 1993 Long Term Incentive and Share Award
Plan, incorporated by reference to Exhibit 10.9.1 to the
Company's Annual Report on Form 10-K (No. 1-10804) for the
year ended November 30, 1998.
10.9.2 Amendment to Mid Ocean Limited 1993 Long Term Incentive and
Share Award Plan, incorporated by reference to
Exhibit 10.9.2 to the Company's Annual Report on Form 10-K
(No. 1-10804) for the year ended November 30, 1998.
10.10.1 Mid Ocean Ltd. Stock & Deferred Compensation Plan for
Nonemployee Directors, incorporated by reference to
Exhibit 10.10.1 to the Company's Annual Report on Form 10-K
(No. 1-10804) for the year ended November 30, 1998.
10.10.2 Form of Severance Contract between NAC Re Corp. and the
executive officers of NAC Re incorporated herein by
reference to Exhibit 10.10.2 to the Annual Report on
Form 10-K of NAC Re for the year ended December 31, 1988
10.10.3 1997 Incentive and Capital Accumulation Plan incorporated by
reference to Exhibit A to the NAC Re definitive Proxy
Statement filed with the Securities and Exchange Commission.
10.11.1 Mark E. Brockbank Employment Agreement, incorporated by
reference to Exhibit 10.11.1 to the Company's Annual Report
on Form 10-K (No. 1-10804) for the year ended November 30,
1998.
10.11.2 Henry C.V. Keeling Employee Agreement, incorporated by
reference to Exhibit 10.11.2 to the Company's Annual Report
on Form 10-K (No. 1-10804) for the year ended November 30,
1998.
10.11.4 Robert J. Newhouse, Jr. Employment Agreement, incorporated
by reference to Exhibit 10.11.4 to the Company's Annual
Report on Form 10-K (No. 1-10804) for the year ended
November 30, 1998.
10.11.5 Michael A. Butt Employment Agreement, incorporated by
reference to Exhibit 10.11.5 to the Company's Annual Report
on Form 10-K (No. 1-10804) for the year ended November 30,
1998.
10.12.1 Amendment to Brockbank Service Agreement, incorporated by
reference to Exhibit 10.12.1 to the Company's Annual Report
on Form 10-K (No. 1-10804) for the year ended November 30,
1998.
10.12.2 Amendment to Keeling Service Agreement, incorporated by
reference to Exhibit 10.12.2 to the Company's Annual Report
on Form 10-K (No. 1-10804) for the year ended November 30,
1998.
10.12.3 Amendment to Newhouse Service Agreement, incorporated by
reference to Exhibit 10.12.3 to the Company's Annual Report
on Form 10-K (No. 1-10804) for the year ended November 30,
1998.
10.12.4 Amendment to Butt Service Agreement, incorporated by
reference to Exhibit 10.12.4 to the Company's Annual Report
on Form 10-K (No. 1-10804) for the year ended November 30,
1998.
</TABLE>
82
<PAGE>
<TABLE>
<C> <S>
10.13.1 Robert J. Newhouse Consulting Agreement, incorporated by
reference to Exhibit 10.13.1 to the Company's Annual Report
on Form 10-K (No. 1-10804) for the year ended November 30,
1998.
10.13.2 Employment Contract with Nicholas M. Brown, Jr. dated as of
June 30, 1998, incorporated herein by reference to NAC Re's
quarterly report on Form 10Q for June 30, 1998
10.14.1 Credit Agreement (5-Year) between Mid Ocean Limited and The
Chase Manhattan Bank, incorporated by reference to
Exhibit 10.14.1 to the Company's Annual Report on Form 10-K
(No. 1-10804) for the year ended November 30, 1998.
10.14.2 Amendment No. 1 to Credit Agreement (5-Year) between Mid
Ocean Limited and The Chase Manhattan Bank, incorporated by
reference to Exhibit 10.14.2 to the Company's Annual Report
on Form 10-K (No. 1-10804) for the year ended November 30,
1998.
10.14.3 Credit Agreement (364-Day) between Mid Ocean Limited and The
Chase Manhattan Bank, incorporated by reference to
Exhibit 10.14.3 to the Company's Annual Report on Form 10-K
(No. 1-10804) for the year ended November 30, 1998.
10.14.4 Amendment No. 1 to Credit Agreement (364-Day) between Mid
Ocean Limited and The Chase Manhattan Bank, incorporated by
reference to Exhibit 10.14.4 to the Company's Annual Report
on Form 10-K (No. 1-10804) for the year ended November 30,
1998.
10.14.5 Loan Agreement between X.L. America, Inc. and Three Rivers
Funding Corporation, incorporated by reference to
Exhibit 10.14.5 to the Company's Annual Report on Form 10-K
(No. 1-10804) for the year ended November 30, 1998.
10.14.6 Letter of Credit Facility and Reimbursement Agreement by and
among X.L. Insurance Company, Ltd. et al. and Mellon Bank,
N.A., incorporated by reference to Exhibit 10.14.6 to the
Company's Annual Report on Form 10-K (No. 1-10804) for the
year ended November 30, 1998.
10.14.7 First Amendment to Letter of Credit Facility and
Reimbursement Agreement by and among X.L. Insurance Company,
Ltd. et al. and Mellon Bank, N.A., incorporated by reference
to Exhibit 10.14.7 to the Company's Annual Report on
Form 10-K (No. 1-10804) for the year ended November 30,
1998.
10.14.8 Second Amendment to Letter of Credit Facility and
Reimbursement Agreement by and among X.L. Insurance Company,
Ltd. et al. and Mellon Bank, N.A., incorporated by reference
to Exhibit 10.14.8 to the Company's Annual Report on
Form 10-K (No. 1-10804) for the year ended November 30,
1998.
10.14.9 Short Term Revolving Credit Agreement between X.L. Insurance
Company, Ltd. and Mellon Bank, N.A., incorporated by
reference to Exhibit (b)(1) of Amendment No. 2 to the
Schedule 14D-1 (the "GCR Schedule 14D-1") of EXEL Limited
filed with respect to GCR Holdings Company Limited,
incorporated by reference to Exhibit 10.14.9 to the
Company's Annual Report on Form 10-K (No. 1-10804) for the
year ended November 30, 1998.
10.14.10 First Amendment to Short Term Revolving Credit Agreement
between X.L. Insurance Company, Ltd. and Mellon Bank, N.A.,
incorporated by reference to Exhibit 10.14.10 to the
Company's Annual Report on Form 10-K (No. 1-10804) for the
year ended November 30, 1998.
</TABLE>
83
<PAGE>
<TABLE>
<C> <S>
10.14.11 Second Amendment to Short Term Revolving Credit Agreement
between X.L. Insurance Company, Ltd. and Mellon Bank, N.A.,
incorporated by reference to Exhibit 10.14.11 to the
Company's Annual Report on Form 10-K (No. 1-10804) for the
year ended November 30, 1998.
10.14.12 Third Amendment to Short Term Revolving Credit Agreement
between X.L. Insurance Company, Ltd. and Mellon Bank, N.A.,
incorporated by reference to Exhibit 10.14.12 to the
Company's Annual Report on Form 10-K (No. 1-10804) for the
year ended November 30, 1998.
10.14.13 Fourth Amendment to Short Term Revolving Credit Agreement
between X.L. Insurance Company, Ltd. and Mellon Bank, N.A.,
incorporated by reference to Exhibit 10.14.13 to the
Company's Annual Report on Form 10-K (No. 1-10804) for the
year ended November 30, 1998.
10.14.14 Revolving Credit Agreement between X.L. Insurance Company,
Ltd. and Mellon Bank, N.A., Incorporated by reference to
Exhibit (b)(2) of the GCR Schedule 14D-1, incorporated by
reference to Exhibit 10.14.14 to the Company's Annual Report
on Form 10-K (No. 1-10804) for the year ended November 30,
1998.
10.14.15 First Amendment to revolving Credit Agreement between X.L.
Insurance Company, Ltd. and Mellon Bank, N.A., incorporated
by reference to Exhibit 10.14.15 to the Company's Annual
Report on Form 10-K (No. 1-10804) for the year ended
November 30, 1998.
10.14.16 Second Amendment to Revolving Credit Agreement between X.L.
Insurance Company, Ltd. and Mellon Bank, N.A., incorporated
by reference to Exhibit 10.14.16 to the Company's Annual
Report on Form 10-K (No. 1-10804) for the year ended
November 30, 1998.
11.1 Statement regarding computation of per share earnings.
21.1 List of subsidiaries of the Registrant, incorporated by
reference to Exhibit 21.1 to the Company's Annual Report on
Form 10-K (No. 1-10804) for the year ended November 30, 1998
and by reference to Exhibit 21 to the Annual Report on
Form 10-K (No. 0-13891) of NAC Re for the year ended
December 31, 1998.
23.1 Consent of PriceWaterhouseCoopers LLP
23.2 Consent of Ernst & Young LLP
27.1 Financial Data Schedule.
</TABLE>
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the last quarter of 1998.
84
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Shareholders of XL Capital Ltd:
In our opinion, based upon our audits and the report of other auditors, the
accompanying consolidated balance sheets, the related consolidated statements of
income and comprehensive income, of shareholders' equity and of cash flows
present fairly, in all material respects, the financial position of XL Capital
Ltd. and its subsidiaries at December 31, 1998 and 1997, and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 1998, in conformity with generally accepted accounting
principles. In addition, in our opinion, the financial statement schedules
listed in Item 14(a) of this Form 10-K, when considered in relation to the basic
financial statements taken as a whole, present fairly, in all material respects,
the information required to be included therein. These financial statements and
financial statement schedules are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements and financial statement schedules based on our audits. We conducted
our audits of these statements in accordance with generally accepted auditing
standards, which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above. We did not
audit the financial statements or financial statement schedules of NAC Re Corp.,
which statements reflect total assets of $3,227,632 and $2,984,865 as of
December 31, 1998 and 1997, respectively, and total revenues of $699,379,
$740,372 and $650,241 for the years ended December 31, 1998, 1997 and 1996,
respectively. Those statements and schedules were audited by other auditors
whose report thereon has been furnished to us, and our opinion expressed herein,
insofar as it relates to the amounts included for NAC Re Corp., is based solely
on the report of the other auditors.
We previously audited and reported on the consolidated balance sheets, the
related consolidated statements of income and comprehensive income, of
shareholders' equity and of cash flows and the supplemental schedules of XL
Capital Ltd. and its subsidiaries as at and for the years ended November 30,
1998 and 1997, prior to their restatement for the 1999 pooling of interests and
change in fiscal year. We also audited the combination of the accompanying
consolidated statements of income and cash flows for the year ended
December 31, 1998, after restatement for the 1999 pooling of interests in our
opinion, such consolidated statements have been properly combined on the basis
described in Note 6 of the consolidated financial statements.
PricewaterhouseCoopers LLP
New York, New York
November 23, 1999
85
<PAGE>
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Shareholders of
NAC Re Corporation:
We have audited the consolidated balance sheets of NAC Re Corporation and
subsidiaries as of December 31, 1998 and 1997 and the related consolidated
statements of income, stockholder's equity and cash flows for each of the three
years in the period ended December 31, 1998 (not presented separately herein).
Our audits also included the financial statement schedules listed in the Index
at Item 14 of the 1998 NAC Re Corporation annual report on Form 10-K (not
presented separately herein). These financial statements and schedules are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements and schedules based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
NAC Re Corporation and subsidiaries at December 31, 1998 and 1997, and the
consolidated results of their operations and cash flows for each of the three
years in the period ended December 31, 1998, in conformity with generally
accepted accounting principles. Also, in our opinion, the related financial
statement schedules, when considered in relation to the basic financial
statements taken as a whole, present fairly in all respects, the information set
forth therein.
Ernst & Young LLP
New York, New York
February 3, 1999
except for Note 15, as to which the date is
February 15, 1999
86
<PAGE>
XL CAPITAL LTD
SUPPLEMENTAL SCHEDULE I
CONSOLIDATED SUMMARY OF INVESTMENTS--OTHER THAN
INVESTMENTS IN RELATED PARTIES
DECEMBER 31, 1998
(U.S DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
AMOUNT AT
WHICH SHOWN
COST OR IN THE
AMORTIZED MARKET BALANCE
TYPE OF INVESTMENT COST(1) VALUE SHEET
------------------ ---------- ---------- -----------
<S> <C> <C> <C>
Fixed Maturities:
Bonds and notes:
U.S. government and government agencies and
authorities........................................ $1,876,198 $1,890,766 $1,890,766
U.S. states and political subdivisions of the
States............................................. 1,265,247 1,324,226 1,324,226
Non-U.S. sovereign governments....................... 687,096 696,026 696,026
All other corporate.................................. 3,605,183 3,601,885 3,601,885
---------- ---------- ----------
Total fixed maturities............................. $7,433,724 $7,512,903 $7,512,903
---------- ---------- ----------
Equity Securities:....................................... $1,127,590 $1,299,098 $1,299,098
---------- ---------- ----------
Short-term investments................................... $ 246,085 $ 245,891 $ 245,891
---------- ---------- ----------
Total investments........................................ $8,807,399 $9,057,892 $9,057,892
========== ========== ==========
</TABLE>
- ------------------------
(1) Investments in fixed maturities and short-term investments are shown at
amortized cost.
87
<PAGE>
XL CAPITAL LTD
SCHEDULE II
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED BALANCE SHEETS--PARENT COMPANY ONLY
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
(IN THOUSANDS)
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
A S S E T S
Portfolio Investments:
Fixed maturities at fair value (amortized cost:
1998--$244,239; 1997--$NIL)............................. $ 245,713 $ --
Short-term investments at fair value (amortized cost:
1998--$5,569; 1997--$NIL)............................... 5,698 --
---------- ----------
Total portfolio investments........................... 251,411 --
Cash and cash equivalents................................... 148,681 --
Investments in subsidiaries................................. 5,983,598 2,840,802
Investment in affiliate (cost: 1998--$NIL;
1997--$188,137)........................................... -- 358,423
Investments in limited partnership.......................... 20,378 22,432
Accrued investment income................................... 1,967 --
Other assets................................................ 3,888 3,257
---------- ----------
Total assets.......................................... $6,409,923 $3,224,914
========== ==========
L I A B I L I T I E S
Amount due to subsidiaries.................................. $ 679,799 $ 28,046
Accounts payable and accrued liabilities.................... 117,521 1,119
---------- ----------
Total liabilities..................................... $ 797,320 $ 29,165
---------- ----------
S H A R E H O L D E R S' E Q U I T Y
Ordinary shares............................................. $ 1,287 $ 1,013
Contributed surplus......................................... 2,508,062 506,452
Accumulated other comprehensive income...................... 235,185 251,471
Deferred compensation....................................... (22,954) (18,263)
Retained earnings........................................... 2,891,023 2,455,076
---------- ----------
Total shareholders' equity............................ $5,612,603 $3,195,749
---------- ----------
Total liabilities and shareholders' equity............ $6,409,923 $3,224,914
========== ==========
</TABLE>
88
<PAGE>
XL CAPITAL LTD
SCHEDULE II
CONDENSED FINANCIAL INFORMATION OF REGISTRANT(CONTINUED)
STATEMENT OF INCOME--PARENT COMPANY ONLY
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(U.S DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Net investment income....................................... $ 2,738 $ 64 $ 617
Net realized gains.......................................... 458 -- --
Equity in net income of subsidiaries (Dividends were
$177,900, $186,548 and $302,048 in 1998, 1997 and 1996,
respectively)............................................. 632,521 749,554 461,667
Equity in net income of affiliate........................... 49,878 62,135 59,374
Income from limited partnership............................. 3,599 4,342 --
-------- -------- --------
Total revenues.............................................. 689,194 816,095 521,658
Operating expenses.......................................... 32,864 7,066 5,187
-------- -------- --------
Net income.................................................. $656,330 $809,029 $516,471
-------- -------- --------
Change in net unrealized appreciation on investments........ 1,603 -- --
-------- -------- --------
Comprehensive income........................................ $657,933 $809,029 $516,471
======== ======== ========
</TABLE>
89
<PAGE>
XL CAPITAL LTD
SCHEDULE II
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)
STATEMENT OF CASH FLOWS--PARENT COMPANY ONLY
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(U.S DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Cash flows provided by operating activities:
Net income................................................ $ 656,330 $ 809,029 $ 516,471
Adjustments to reconcile net income to net cash provided
by operating activities:
Net realized gains from sale of shares in affiliate..... (458) -- --
Equity in net income of subsidiaries net of dividends... (503,838) (553,607) (121,457)
Equity in net income of affiliate net of dividends...... (31,410) (34,849) (44,592)
Accrued investment income............................... (1,967) -- --
Amount due from subsidiaries............................ 651,753 37,151 65,669
Accounts payable and accrued liabilities................ 116,402 (444) (1,457)
Amortization of intangible assets....................... 10,494 -- --
Amortization of deferred compensation................... 5,815 5,237 2,422
Amortization of discounts on fixed maturities........... 335 -- --
--------- --------- ---------
Total adjustments..................................... 250,126 (546,512) (99,415)
--------- --------- ---------
Net cash provided by operating activities............. 903,456 262,517 417,056
--------- --------- ---------
Cash flows provided by (used in) investing activities:
Proceeds from sale of fixed maturities and short-term
investments........................................... 198,893 -- --
Proceeds from redemption of fixed maturities and
short-term investments................................ 53,325 -- --
Purchases of fixed maturities and
short-term investments................................ (501,957) -- --
Other assets............................................ (631) (64) 7,115
Investment in affiliate................................. -- -- (1,620)
Investment in limited partnership....................... (1,129) 203 (23,509)
--------- --------- ---------
Net cash provided (used in) by investing activities..... (251,499) 139 (18,014)
--------- --------- ---------
Cash flows used in financing activities:
Issuance of restricted shares........................... 514 387 695
Proceeds from exercise of options....................... 15,092 12,284 4,482
Dividends paid.......................................... (156,481) (120,607) (90,898)
Repurchase of treasury shares........................... (362,401) (154,720) (313,321)
--------- --------- ---------
Net cash used in financing activities................. (503,276) (262,656) (399,042)
--------- --------- ---------
Net change in cash and cash equivalents............... $ 148,681 $ -- $ --
--------- --------- ---------
Cash and cash equivalents--beginning of year................ -- -- --
--------- --------- ---------
Cash and cash equivalents--end of year...................... $ 148,681 $ -- $ --
========= ========= =========
</TABLE>
90
<PAGE>
XL CAPITAL LTD
SCHEDULE IV--REINSURANCE
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(U.S DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
CEDED ASSUMED
GROSS TO OTHER FROM OTHER NET
AMOUNT COMPANIES COMPANIES AMOUNT
-------- --------- ---------- ----------
<S> <C> <C> <C> <C>
1998.............................................. $779,551 $319,275 $863,988 $1,324,264
-------- -------- -------- ----------
1997.............................................. $517,773 $254,940 $617,612 $ 880,445
-------- -------- -------- ----------
1996.............................................. $658,369 $279,604 $788,103 $1,166,868
-------- -------- -------- ----------
</TABLE>
91
<PAGE>
XL CAPITAL LTD
SCHEDULE VI
SUPPLEMENTARY INFORMATION
CONCERNING PROPERTY/CASUALTY INSURANCE OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(U.S. DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
LOSSES AND LOSS
EXPENSES INCURRED
RESERVES RESERVES RELATED TO PAID
DEFERRED FOR LOSSES FOR NET NET ---------------------- LOSSES
ACQUISITION AND LOSS UNEARNED EARNED INVESTMENT CURRENT PRIOR AND LOSS
COSTS EXPENSES PREMIUMS PREMIUMS INCOME YEAR (1) YEAR (2) EXPENSES
----------- ---------- ---------- ---------- ---------- ---------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
1998................. $204,271 $4,896,643 $1,337,277 $1,324,291 $417,290 $1,085,161 $(243,617) $730,171
-------- ---------- ---------- ---------- -------- ---------- --------- --------
1997................. $113,566 $3,972,376 $ 824,369 $1,114,758 $345,115 $1,056,228 $(317,379) $331,609
-------- ---------- ---------- ---------- -------- ---------- --------- --------
1996................. $114,120 $3,623,334 $ 951,427 $1,038,643 $304,823 $ 757,934 $ (18,876) $501,944
-------- ---------- ---------- ---------- -------- ---------- --------- --------
<CAPTION>
AMORTIZATION
OF DEFERRED NET
ACQUISITION PREMIUMS
COSTS WRITTEN
------------ ----------
<S> <C> <C>
1998................. $249,341 $1,324,264
-------- ----------
1997................. $198,017 $ 880,445
-------- ----------
1996................. $177,497 $1,166,868
-------- ----------
</TABLE>
92
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
<TABLE>
<S> <C> <C>
XL CAPITAL LTD
By /s/ BRIAN M. O'HARA
-----------------------------------------
Brian M. O'Hara
President and Chief Executive Officer
</TABLE>
November 29, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
NAME TITLE DATE
---- ----- ----
<C> <S> <C>
President, Chief Executive
/s/ BRIAN M. O'HARA Officer and Director
------------------------------------------- (Principal Executive November 29, 1999
Brian M. O'Hara Officer)
Executive Vice President
and Chief Financial
/s/ ROBERT R. LUSARDI Officer (Principal
------------------------------------------- Financial Officer and November 29, 1999
Robert R. Lusardi Principal Accounting
Officer)
/s/ MICHAEL ESPOSITO JR.
------------------------------------------- Director and Chairman of November 29, 1999
Michael Esposito Jr. the Board of Directors
/s/ RONALD BORNHUETTER
------------------------------------------- Director November 29, 1999
Ronald Bornhuetter
/s/ MICHAEL A. BUTT
------------------------------------------- Director November 29, 1999
Michael A. Butt
/s/ ROBERT CLEMENTS
------------------------------------------- Director November 29, 1999
Robert Clements
</TABLE>
93
<PAGE>
<TABLE>
<CAPTION>
NAME TITLE DATE
---- ----- ----
<C> <S> <C>
/s/ SIR BRIAN CORBY
------------------------------------------- Director November 29, 1999
Sir Brian Corby
/s/ ROBERT R. GLAUBER
------------------------------------------- Director November 29, 1999
Robert R. Glauber
/s/ ROBERT V. HATCHER, JR.
------------------------------------------- Director November 29, 1999
Robert V. Hatcher, Jr.
/s/ IAN R. HEAP
------------------------------------------- Director November 29, 1999
Ian R. Heap
/s/ PAUL JEANBART
------------------------------------------- Director November 29, 1999
Paul Jeanbart
/s/ JOHN LOUDON
------------------------------------------- Director November 29, 1999
John Loudon
/s/ DANIEL J. MCNAMARA
------------------------------------------- Director November 29, 1999
Daniel J. McNamara
/s/ ROBERT J. NEWHOUSE, JR.
------------------------------------------- Director November 29, 1999
Robert J. Newhouse, Jr.
/s/ ROBERT S. PARKER
------------------------------------------- Director November 29, 1999
Robert S. Parker
/s/ CYRIL RANCE
------------------------------------------- Director November 29, 1999
Cyril Rance
/s/ ALAN Z. SENTER
------------------------------------------- Director November 29, 1999
Alan Z. Senter
</TABLE>
94
<PAGE>
<TABLE>
<CAPTION>
NAME TITLE DATE
---- ----- ----
<C> <S> <C>
/s/ JOHN T. THORNTON
------------------------------------------- Director November 29, 1999
John T. Thornton
/s/ ELLEN E. THROWER
------------------------------------------- Director November 29, 1999
Ellen E. Thrower
/s/ JOHN WEISER
------------------------------------------- Director November 29, 1999
John Weiser
</TABLE>
95
<PAGE>
EXHIBIT 11.1
XL CAPITAL LTD
COMPUTATION OF EARNINGS PER ORDINARY SHARE
AND ORDINARY SHARE EQUIVALENT
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
BASIC EARNINGS PER SHARE:
Net income.................................................. $656,330 $809,029 $516,471
Weighted average ordinary shares outstanding................ 112,034 101,708 107,339
Basic earnings per share.................................... $ 5.86 $ 7.95 $ 4.81
======== ======== ========
DILUTED EARNINGS PER SHARE:
Net income.................................................. $656,330 $809,029 $516,471
Add back after-tax interest on convertible debentures....... 3,504 3,504 3,504
-------- -------- --------
Adjusted net income......................................... $659,834 $812,533 $519,975
-------- -------- --------
Weighted average ordinary shares outstanding................ 112,034 101,708 107,339
Average stock options outstanding (1)....................... 2,152 1,277 549
Assumed conversion of convertible debentures (2)............ 2,020 2,020 2,020
-------- -------- --------
Weighted average ordinary shares outstanding................ 116,206 105,005 109,908
-------- -------- --------
Diluted earnings per share.................................. $ 5.68 $ 7.74 $ 4.73
======== ======== ========
</TABLE>
- ------------------------
(1) Net of shares repurchased under the treasury stock method
(2) Reflects the assumed conversion of the NAC Re 5.25% Convertible Subordinated
Debentures due 2002.
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the inclusion in this Form 10-K of our report dated
November 23, 1999, on our audits of the financial statements and financial
statement schedules of XL Capital Ltd which states that we did not audit the
financial statements and financial statement schedules of NAC Re Corp. and that
our opinion, in so far as it relates to the amounts included for NAC Re Corp.,
is based solely on the report of other auditors, which report is included
herein.
We further consent to the incorporation by reference in the registration
statements of XL Capital Ltd on Form S-3 (File No. 33-76170), Form S-8 (File
No. 33-86826), Form S-8 and S-3 (File No. 33-86824) and Form S-8 (File
No. 333-81451) of our report dated November 23, 1999 on our audits of the
financial statements and financial statement schedules of XL Capital Ltd.
PRICEWATERHOUSECOOPERS LLP
New York, New York
November 29, 1999
<PAGE>
EXHIBIT 23.2
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the use of our report, on the consolidated financial
statements of NAC Re Corporation for the year ended December 31, 1998, dated
February 3, 1999 except for Note 15, as to which the date is February 15, 1999
in this Annual Report on Form 10K of XL Capital Ltd.
ERNST & YOUNG LLP
New York, New York
November 26, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<DEBT-HELD-FOR-SALE> 7,758,794
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 1,299,098
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 9,057,893
<CASH> 480,874
<RECOVER-REINSURE> 593,960
<DEFERRED-ACQUISITION> 204,271
<TOTAL-ASSETS> 13,581,140
<POLICY-LOSSES> 4,896,643
<UNEARNED-PREMIUMS> 1,337,777
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 613,873
0
0
<COMMON> 1,287
<OTHER-SE> 5,611,316
<TOTAL-LIABILITY-AND-EQUITY> 13,581,140
1,374,291
<INVESTMENT-INCOME> 417,290
<INVESTMENT-GAINS> 211,204
<OTHER-INCOME> 72,617
<BENEFITS> 841,517
<UNDERWRITING-AMORTIZATION> 249,341
<UNDERWRITING-OTHER> 247,582
<INCOME-PRETAX> 686,962
<INCOME-TAX> 24,883
<INCOME-CONTINUING> 656,330
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 656,330
<EPS-BASIC> 5.86
<EPS-DILUTED> 5.68
<RESERVE-OPEN> 3,608,660
<PROVISION-CURRENT> 1,085,161
<PROVISION-PRIOR> (243,644)
<PAYMENTS-CURRENT> 271,738
<PAYMENTS-PRIOR> 458,433
<RESERVE-CLOSE> 4,302,683
<CUMULATIVE-DEFICIENCY> 255,320
</TABLE>
