<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------
FORM 10-K/A
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended November 30, 1998
Commission file number 1-10804
----------------
XL Capital Ltd
(Exact name of registrant as specified in its charter)
Cayman Islands 98-0058718
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
Cumberland House, 1 Victoria Street, HM 11
Hamilton, Bermuda (Zip Code)
(Address of principal executive
offices)
(441) 292-8515
(Registrant's telephone number, including area code)
----------------
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
<TABLE>
<CAPTION>
Name of each exchange
Title of each class on which registered
------------------- ---------------------
<S> <C>
Class A Ordinary Shares, Par Value $0.01 New York Stock Exchange, Inc.
per Share
</TABLE>
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 February 19, 1999
was approximately $6.9 billion computed upon the basis of the closing sales
price of all 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 February 19, 1999, there were outstanding 108,423,500 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 to be filed with the Securities
and Exchange Commission pursuant to Regulation 14A relating to the annual
meeting of shareholders scheduled to be held on April 9, 1999 is incorporated
by reference in Part III of this Form 10-K.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
XL CAPITAL LTD
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
PART I
<S> <C> <C>
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................................................................ 23
Item 7. Management's Discussion and Analysis of Results of Operations and Financial Condition . 24
Item 8. Financial Statements and Supplementary Data............................................ 34
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure... 63
PART III
Item 10. Directors and Executive Officers of the Registrant..................................... 63
Item 11. Executive Compensation................................................................. 63
Item 12. Security Ownership of Certain Beneficial Owners and Management......................... 63
Item 13. Certain Relationships and Related Transactions......................................... 63
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K........................ 63
</TABLE>
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."
<PAGE>
PART I
Item 1. Business
Introduction
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"). In the merger, which was completed on
August 7, 1998, all of the shares of EXEL and Mid Ocean were exchanged for
shares in the Company pursuant to two schemes of arrangement (the
"Arrangements") 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.
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. ("XLIA")), 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 ("XLRS"). XLI also has a representative office in
Australia.
The Company's reinsurance operations are conducted primarily through XL Mid
Ocean Reinsurance Ltd, an insurance company organized under the laws of
Bermuda ("XLMORe"), and its subsidiaries. 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 ("GCR"), on June 12,
1997. XLRe commenced operations on December 1, 1995 to write specialty
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. Each of XLRe, MORe and GCRe was organized as an
insurance company under the laws of Bermuda. XLMORe maintains branches in
London and Singapore and a European contact office in Munich.
The Company's operations at Lloyd's are conducted through The Brockbank
Group plc, a company organized under the laws of England, and its subsidiaries
(together, "Brockbank"). Brockbank is a leading Lloyd's managing agency which
manages five Lloyd's syndicates, two of which 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 the underwriting services it
provides to syndicates.
1
<PAGE>
In October 1998, the Company sold its 21% interest in Venton Holdings
Limited, a Bermuda holding company for the Venton managing agency group at
Lloyd's (together, the "Venton Group"). Prior to the sale, subsidiaries of the
Company provided reinsurance coverage to the Venton Group, which writes
principally professional indemnity, directors and officers liability and
fiduciary liability insurance coverages.
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 enter. 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 (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.
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 such company's management for the purpose of providing life
insurance to high net worth individuals. Reeve Court has a total
capitalization of approximately $100 million.
In October 1997, the Company and Risk Capital Holdings, Inc., a Delaware
corporation ("RCHI"), which holds all of the outstanding shares of Risk
Capital Reinsurance Company, a Nebraska corporation ("RCRe"), organized LARC
Holdings, Ltd., a Bermuda corporation ("LARC"), which holds all of the shares
of Latin American Reinsurance Company, Ltd., a Bermuda insurance company
("LARe"). LARe has approximately $100 million in shareholders' equity and
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. XLMORe owns approximately 75% of the outstanding
shares of LARC. The Company indirectly owns approximately 28% of RCHI.
In March 1997, XLI became a founding shareholder along with RCHI and another
insurance company of Sovereign Risk Insurance Ltd. ("Sovereign"), a Bermuda-
based managing general agency formed to underwrite selected political risk
insurance coverages. The Company owns 40.5% of Sovereign.
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/XLSM foreign currency
protection product offered by XLI.
On December 2, 1998, the Company signed a definitive agreement to acquire
all of the outstanding shares of Intercargo Corporation, a Delaware
corporation ("Intercargo"), for $12.00 per share, or approximately $88
million. Intercargo, through its subsidiaries, underwrites specialty insurance
products for companies engaged in international trade, including U.S. customs
bonds and marine cargo insurance. At September 30, 1998, Intercargo had total
assets of $165 million and shareholders' equity of $81 million. The
transaction is subject to approval by Intercargo's shareholders, regulatory
approvals and customary closing conditions.
Each of XLI, XLE and XLMORe possesses claims paying ratings of AA from
Standard & Poor's Corporation ("S&P") and A+ from A.M. Best Company, Inc.
2
<PAGE>
Business Strategy
The Company's strategy is to be the premier provider of strategic financial
risk solutions to specific global markets by applying intellectual and
financial resources to assure its customers' economic vitality and enhance
their competitive positions. Management believes that pursuing this strategy
will improve the Company's ability to differentiate itself from its
competitors, diversify its mix of business and revenue stream, reduce its
dependence on business lines which may be highly price sensitive and build
shareholder value.
The Company's strategy calls for its subsidiaries to go beyond offering
traditional insurance and reinsurance products to designing risk transfer
programs that address specific customer needs with respect to a broad range of
risks. These include certain types of financial risks and other non-
traditional insurance risks which the Company believes can be properly
analyzed and underwritten. As part of this approach, the Company's strategy
contemplates providing income statement and balance sheet protection to its
customers, involving in some instances structured portfolio transfers of
strategic importance to its customers. The Company also believes there will be
opportunities to build investment features into its risk transfer products.
The Company intends to retain its traditional focus generally on high
severity, low frequency risks.
In order to pursue its strategy effectively, the Company may need to secure
access to skills and capabilities in areas which historically have not been
found in the insurance and reinsurance industry. Accordingly, successful
implementation of the Company's strategy is expected to involve not only
maximizing its financial strength but attracting and retaining highly skilled
and motivated employees. It may also require entering into coordinated
initiatives, joint ventures or alliances with one or more strategic partners,
making strategic investments and, where appropriate, acquiring other
businesses of strategic value to the Company and its subsidiaries.
Business Operations
The Company reported net premiums written of $649.9 million, $439.4 million
and $467.7 million for the years ended November 30, 1998, 1997 and 1996,
respectively.
<TABLE>
<CAPTION>
Net Premiums Written 1998 1997 1996
($ in millions) -------------- ------------- ---------------
<S> <C> <C> <C> <C> <C> <C>
Insurance.......................... $350.3 52.1% $296.4 93.6% $ 452.2 75.7%
Reinsurance........................ 238.9 35.6% 20.2 6.4% 144.9 24.3%
Lloyd's Syndicates................. 82.8 12.3% -- -- -- --
------ ------ ------ ------ ------- ------
$672.0 100.0% $316.6 100.0% $ 597.1 100.0%
====== ====== ======
Multi-year premiums................ (22.1) 122.8 (129.4)
------ ------ -------
Annualized net premiums written.... $649.9 $439.4 $ 467.7
====== ====== =======
</TABLE>
Insurance
The Company, through its subsidiaries, provides third-party general
liability insurance, other liability insurance (including 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 is characterized as low frequency and high severity.
Property insurance is written on a pro rata as well as an excess basis.
Property 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 than those associated with the Company's other insurance lines.
<TABLE>
<CAPTION>
Net Premiums Written 1998 1997 1996
($ in millions) ------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
General liability..................... $136.1 38.9% $150.8 50.9% $319.7 70.7%
Other liability....................... 152.5 43.5% 116.2 39.2% 101.8 22.5%
Property.............................. 24.8 7.1% 29.4 9.9% 30.7 6.8%
Other................................. 36.9 10.5% -- -- -- --
------ ------ ------ ------ ------ ------
$350.3 100.0% $296.4 100.0% $452.2 100.0%
====== ====== ====== ====== ====== ======
</TABLE>
3
<PAGE>
As the Company's U.S. insurance subsidiaries were not yet fully operational
in 1998, the descriptions which follow relate to coverages offered by XLI and
XLE. The descriptions which follow are summary in nature. The terms and
conditions of individual policies 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.
General Liability
General liability policies offered by the Company's insurance subsidiaries
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. With respect to the use of
products, the coverage applies where unexpected and unintended personal injury
or property damage to a third party caused, allegedly caused or deemed to have
been caused by the use of a product takes place during the term of the policy.
Where certain injury, damage or liability to third parties is expected or
intended by the insured, the policy provides coverage for injury, damage or
liability when the actual injury, damage or liability incurred is
fundamentally different in nature or vastly greater in order of magnitude than
expected. All claims for integrated occurrences are added together and treated
as one occurrence (thereby limiting such losses to one policy limit) with
respect to the policy in effect when the occurrence or claim is first reported
regardless of the length of the period over which such losses or liabilities
occur, although special notice requirements are imposed with respect to such
losses. The general liability policies generally do not "drop down" to provide
coverage below the per-occurrence attachment point even in the event of
exhausted underlying insurance policy aggregates.
Coverage includes product liability, claims resulting from abrupt pollution,
punitive damages (for unexpected or unintended damage/injury) and payment of
legal fees, as well as a broad range of catastrophic exposures such as
explosions, fires, utility blackouts and other catastrophic events not
excluded from coverage. Coverage generally excludes gradual pollution (other
than gradual pollution resulting from a products liability claim), property
damage arising out of most professional services, commercial airline risks,
certain marine exposures, and liability for injury or damage caused by, among
other things, asbestos, tobacco, intra-uterine devices, silicone implants and
nuclear risks. Unlike traditional insurance policy forms, disputes under the
policies are required to be settled by arbitration in London. Under the policy
arbitration clause, each party selects one arbitrator and the two arbitrators
so selected choose a third arbitrator. The English Arbitration Act of 1950, as
amended and supplemented, governs the arbitration under XLI policies (with
International Chamber of Commerce rules governing XLE policies).
Rather than issuing separate annual policies, a perpetual policy is issued
(which is subject to an annual underwriting review) with an annual aggregate
limit (subject to reinstatement). The policy remains in effect until canceled
or not continued. The terms, conditions, exclusions, deductibles and limit
applicable to an occurrence are determined by the policy in effect at the time
notice thereof is first given. Coverage is provided on an occurrence-reported
policy form up to a maximum of $200 million per occurrence and annual
aggregate in excess of a minimum attachment point of $15 million per
occurrence. Because the inception date (or, if applicable, the retroactive
date) remains unchanged, the exposure under each policy usually increases each
additional year that the policy is in force. The exposure to unreported claims
thus rolls forward each year, which is provided for by the establishment of
significant incurred but not reported ("IBNR") reserves. Each year's coverage,
however, is subject to an aggregate limit, and the limits of any given year
are not available for occurrences first reported in a subsequent year
notwithstanding that the injury or damage took place in that year. Premiums
are adjusted annually. A single event or set of circumstances may constitute
an insured occurrence under policies of different policyholders, resulting in
multiple claims exposure with respect thereto. Such events or circumstances
could have a material adverse effect on the results of the Company.
The policy permits cancellation by the insurer with refund of the unearned
premium at any time, except in the case of discovery period coverage, upon 90
days' prior written notice to the policyholder. The policy permits
4
<PAGE>
cancellation by a policyholder at any time with a pro-rata refund of premium.
If the basic coverage of the policy is canceled or discontinued, the insured
is given the option of purchasing discovery coverage (in respect of
occurrences taking place subsequent to the inception/retroactive date and
prior to cancellation or discontinuance of basic coverage) on an ongoing basis
for as long as is desired by the policyholder (with no maximum duration) for
predetermined annual premiums.
As contrasted with the standard policy form which provides for annual
determination of premiums and limits, the Company offers to certain of its
policyholders endorsements providing cover generally for two additional annual
periods (aggregating a total of three years), with either an annual aggregate
or term limit and with the provision for reinstatement of the limit selected.
Premiums are generally prepaid in whole or in part for the period of the
contract. Such endorsements limit the circumstances under which either the
policyholder or the insurer may cancel and provide that the otherwise
predetermined premium for the three-year period may be adjusted in certain
specified circumstances. It is contemplated that policyholders may be given
the opportunity to roll the three-year term forward year-by-year based on
premiums and other terms and conditions to be negotiated each year.
Other Liability
Other liability includes directors and officers liability insurance,
professional liability insurance, employment practices liability insurance and
integrated liability insurance branded as XL Risk Solutions.
Directors and Officers Liability. Directors and Officers liability 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. The policy generally adopts the terms, conditions and exclusions in
the primary or other underlying policy. Each insured is rated separately. In
contrast to the general liability policy, the directors and officers policy is
for a designated period. Also, unlike the general liability policy, the
directors and officers policy "drops down" upon erosion or exhaustion of
underlying aggregates by multiple claims. The policy can be canceled by the
insurer upon typically 90 days' notice (with the insurer retaining a pro rata
proportion of the premium) or by the policyholder at any time with the insurer
retaining a short rate proportion (i.e., more than pro rata) of the premium.
If the insurer cancels or refuses to renew the policy, the policyholder is
given the option of purchasing discovery coverage for a specified period of
time (generally one to three years) at a predetermined premium. As with the
general liability form, disputes are required to be settled by arbitration in
London. Under the policy arbitration clause, each party selects one arbitrator
and the two arbitrators so selected choose a third arbitrator.
Professional Liability. 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. The policy covers "wrongful acts" (instead of occurrences), subject to
customary exclusions, and covers punitive damages arising therefrom. As with
the other policy forms, disputes are required to be settled by arbitration in
London. In contrast to the general liability policy, the discovery period is
of finite duration (generally one to three years). Where the policy is written
on a claims made "stand alone" basis (i.e., it does not follow the warranties,
terms, conditions or exclusions of underlying policies), it does "drop down"
upon erosion or exhaustion of the aggregate limits of underlying policies by
multiple wrongful acts in the case of law firms and certain other insureds
(i.e., in these instances the attachment point applies on an aggregate rather
than a per wrongful act basis). The underlying policies of an insured seeking
professional liability coverage are reviewed and evaluated as part of the
underwriting process.
Employment Practices Liability. In 1997, XLI introduced coverage for
employment practices liability. Coverage is provided up to $100 million with a
minimum attachment of $1 million. Employment practices
5
<PAGE>
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 such as job
discrimination, sexual harassment and other employment related misconduct. As
with other XLI products, the employment practices liability policy has XLI's
standard arbitration clause which requires disputes to be settled by
arbitration in London.
XL Risk Solutions. XL Risk Solutions is a coordinated initiative with CIGNA
Risk Solutions offering 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 Corporation ("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 traditional
stated levels subject to the underwriting requirements. Programs are typically
custom designed to meet specific needs with each customer.
Property
Property policies are primarily underwritten 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 have annual aggregate
limits. All classes of business are considered. The minimum attachment points
are generally $25 million for industrial/commercial accounts and $100 million
for oil/petrochemical accounts. Industrial/commercial accounts will also be
written on a pro rata basis with attachments as low as $1 million.
Coverage can be provided worldwide on an all-risk or named peril basis of
direct physical loss or damage with options for time element (e.g., business
interruption, extra expense, rental value, etc.), earthquake, flood, and
boiler and machinery coverage. Policies can be written on a modified follow
form or XLI form. Typical exclusions include but are not limited to war risk,
nuclear, pollution, and others customary in property policy coverage. Unlike
traditional property policies, disputes under XLI policies are required to be
settled by arbitration in London with each party selecting one arbitrator and
the two arbitrators so selected choosing a third arbitrator.
The maximum net capacity for any of the insurance subsidiaries for any one
insured is $100 million per occurrence with $10 million annual aggregate for
high frequency/severity earthquake (California, Japan, etc.) when provided.
Earthquake and coastal wind exposures are identified and monitored (policy
limit accumulations) by subzones worldwide in order to limit exposure to an
excessive concentration of catastrophic loss.
Other
Insurance is also provided to cover political risk. Political risk
insurance, including coverages for expropriation, currency inconvertibility
and certain other types of political risk associated with cross-border
investment, is provided through the Company's interest in Sovereign. Policies
written by Sovereign are subscribed 50% by each of XLI and Sovereign's other
insurance company shareholder, with RCRe participating in up to 10% of each
risk written on a quota share 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.
6
<PAGE>
XLI also offers insurance and reinsurance solutions for certain types of
financial risks. In 1998, XLI introduced a foreign currency protection product
and began writing financial guaranty insurance and reinsurance in respect of
selected credit 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 the risk 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 generally will 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
generally will 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
financial market volatility or illiquidity, and uncertainties surrounding the
application of Pareto's technology, which is predicated on a basket option
approach, to 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
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 or 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 or reinsurance risks, including residual value insurance
for certain asset classes. The underlying risks guaranteed include both OECD
(Organization of Economic Cooperation and Development) and emerging market
issuers and assets. Guarantees provided by XLI an XLFA relate generally, but
not exclusively, to investment grade 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 $100 million. XLI and XLFA also
may provide financial guaranty "fronting" services in return for fees and
other revenues on behalf of insurers or reinsurers whose claims paying ratings
are below their own. The fronting party is generally required to pay the full
amount of any claim even if it cannot recover all or part of the balance due
from an insurer or reinsurer for which the service was provided.
Reinsurance
The Company, through its subsidiaries, writes property catastrophe, property
excess of loss, property pro rata, marine and energy, aviation and satellite
and various other reinsurance to insurers on a worldwide basis. XLMORe
maintains branch offices in London and Singapore as well as a European contact
office in Munich, Germany. The London branch underwrites marine, energy and
aviation risks on a worldwide basis. The Singapore branch underwrites general
reinsurance, treaty and facultative business.
A significant portion of XLMORe's business underwritten consists of large
aggregate exposures to man-made and natural disasters and generally loss
experience is characterized as low frequency and high severity. This may
result in volatility in the Company's financial results. The Company endeavors
to manage its exposures
7
<PAGE>
to catastrophic events by limiting the amount of its exposure in each
geographic zone worldwide and requiring that its property catastrophe
contracts provide for aggregate limits and varying attachment points.
<TABLE>
<CAPTION>
Net Premiums Written 1998 1997 1996
($ in millions) ------------- -------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Property catastrophe............... $ 76.5 32.1% ($78.9) 44.3% $ 64.1 44.3%
Other property..................... 25.4 10.6% 17.0 9.5% 2.1 1.5%
Marine and energy.................. 24.7 10.3% 17.8 10.0% 20.9 14.4%
Aviation and satellite............. 37.3 15.6% 37.5 21.1% 13.5 9.2%
Other.............................. 75.0 31.4% 26.8 15.1% 44.3 30.6%
------ ------ ------ ------ ------ ------
$238.9 100.0% $ 20.2 100.0% $144.9 100.0%
====== ====== ====== ====== ====== ======
</TABLE>
Property Catastrophe
XLMORe's property catastrophe reinsurance account is generally "all risk" in
nature. It is therefore exposed to losses from sources as diverse as
windstorms, earthquakes, snow and ice storms, riots, floods, industrial
explosions, fires or any number of other potential disasters. In accordance
with market practice, XLMORe's policies generally exclude certain risks such
as war, nuclear contamination or radiation. XLMORe'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 also may 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 XLMORe's property
catastrophe contracts limit coverage to one occurrence in any one policy year,
but most contracts generally provide for one reinstatement.
In 1998, XLMORe's exposure to the following geographic regions based on net
premiums written were as follows: (i) United States 53.5%; (ii) United Kingdom
5.6%; (iii) Japan 2.6%; (iv) worldwide 28.4%; (v) continental Europe 1.7%;
(vi) Australasia 6.6%; (vii) Caribbean 0.6% and (viii) other 1.0%. XLMORe's
exposures in the United States are concentrated primarily in Florida, Texas,
and the southeastern United States with respect to property damage caused by
hurricanes and other wind-related storms and California for property damage
caused by earthquakes.
Other Property
Other property reinsurance written by XLMORe includes property risk excess
of loss and property pro rata business. 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.
XLMORe's property pro rata account includes proportional reinsurance of
direct written property insurance. XLMORe considers this business to be
related to its catastrophe and other property exposures. In proportional
reinsurance, XLMORe 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 reinsurer,
and the ceding insurer may also be entitled to receive a profit commission
based on the ratio of losses, loss adjustment expense and the reinsurer's
expenses to premiums ceded. A proportional reinsurer is dependent upon the
ceding insurer's underwriting, pricing and claims administration to yield an
underwriting profit. In some instances, XLMORe may be entitled to the benefit
of other reinsurance, known as common account reinsurance, purchased by the
ceding company on an account reinsured by XLMORe on a proportional basis.
8
<PAGE>
Marine and energy
XLMORe's marine and energy account is written on both a proportional and
excess of loss basis. The proportional business is based on specific areas of
account that are clearly defined with the exception of the reinsurance of
Brockbank Syndicate 861 which is written on a "whole account" basis.
Aviation and satellite
XLMORe's aviation portfolio comprises both direct insurance and reinsurance,
on both a proportional and excess of loss basis. The exposures are derived
through proportional relationships on defined segments of account following
market leaders in the field, with the exception of the reinsurance of
Brockbank Syndicate 861 which is written on a "whole account" basis. 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.
Other
Other reinsurance written by XLMORe includes political risk, nuclear,
accident, fidelity and professional indemnity.
Lloyd's Syndicates
<TABLE>
<CAPTION>
1998 1997 1996
----- ---- ----
<S> <C> <C> <C>
Net Premiums Written...................................... $82.8 -- --
----- --- ---
($ in millions)
</TABLE>
Brockbank is a leading Lloyd's managing agency which manages five Lloyd's
syndicates, two of which are dedicated corporate syndicates whose capital is
provided solely by the Company. Corporate syndicate number 1209 writes
property, marine and energy, aviation and satellite, professional indemnity,
political risk and other specific lines, primarily of insurance but also
reinsurance, to a globally diverse group of clients. Corporate syndicate
number 2253 writes direct and broker-based motor insurance in the United
Kingdom. These corporate syndicates underwrite parallel to the other
syndicates managed by Brockbank (syndicate number 253 which writes direct
motor insurance and syndicate numbers 588 and 861 which write a composite book
of business).
Reinsurance Ceded
From Insurance Operations
Effective December 1, 1995, 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 RCRe. Under the
terms of the policy, XLI will cede 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. All the reinsurers are rated, of which the lowest as rated by
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 with participations of 16.0%, 18.7% 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
9
<PAGE>
was extended to November 30, 1998 and renewed December 1, 1998. For the year
ended November 30, 1998, 97.75% of this reinsurance was 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 a U.S. insurer and the remaining excess layer of $25
million to a Bermuda-based insurer.
A quota share arrangement exists between XLI and subsidiaries of 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 XLI's normal capacity on individual lines
of cover. XLI may underwrite an account 100% without CIGNA participation.
From Reinsurance Operations
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.
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.
From Lloyd's Operations
Brockbank, as a 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 cover is
purchased to protect the syndicates against extraordinary loss and/or loss
involving one or more of their 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 programmes as
its parallel syndicate 253. Reinsurance cover is purchased on a quota share
and excess of loss basis.
Competition
The property-casualty insurance and reinsurance industry, including the
Lloyd's market, 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-casualty insurance 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
business. Many of the Company's competitors possess significantly greater
financial and other resources than the Company. The Company generally competes
on the basis of price, financial strength, coverage terms, claims paying
reputation and customer service.
10
<PAGE>
Underwriting and Marketing
Underwriting
XLI and XLE write liability and property insurance 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 advisors 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 insurance 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 judgement 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
catastrophe 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 limits 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.
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.
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 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 Operation 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. No
11
<PAGE>
subsidiary of the Company is committed to accept any business from any
particular broker, and brokers do not have the authority to bind any
subsidiary of the Company. All policy applications are subject to approval and
acceptance by the Company's subsidiaries.
Since the Company's inception, J&H Marsh McLennan Global Broking Limited
("J&H Marsh") and its predecessors companies have placed a significant amount
of business with the Company's subsidiaries. In fiscal 1996, 1997 and 1998
approximately 52%, 52% and 45%, respectively, of the Company's consolidated
gross premiums were placed by J&H Marsh or its predecessors and approximately
17%, 19% and 30% respectively, were placed by AON Corporation in fiscal 1996,
1997 and 1998, respectively. 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 any fiscal year during such period.
Unpaid Losses and Loss Expenses
Loss reserves are established due to the significant periods of time that
may elapse 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 IBNR (incurred but not reported) loss reserves are
derived from its insurance operations. This is because the liability business
that these operations write has a much longer tail than the Company's other
operations. The insurance IBNR is estimated in two steps. First, case reserve
development is estimated 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 an
insured, "pure" IBNR losses exist only when claims with a loss notice develop
into their 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.
Several aspects of the Company's insurance operations complicate the
actuarial reserving techniques for loss reserves as compared to other
insurance companies. 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. Accordingly, the ultimate insurance claims experience cannot be
12
<PAGE>
as reliably predicted as may be the case with other insurance companies, and
there can be no assurance that losses and loss expenses will not exceed the
total reserves.
The reinsurance operations and Lloyd's syndicates, unlike the insurance
operations, have industry data available to support estimated reserves. This
data, supported by business knowledge, general market trends and actual
experience, is used to develop reporting patterns and initial expected loss
ratios. Most claims for these operations become known relatively soon. Claims
under 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 often become
known and ascertainable with 36 months of the date of the occurrence giving
rise to the claim, but many significant claims will not become known until
after such period. Motor claims involving property damage will generally be
known and paid within 12 months of the occurrence giving rise to the claim,
but claims involving personal injury can take more than 12 months to resolve.
Conversely, claims on the insurance operations generally 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 prior estimates.
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.
Analysis of Consolidated Loss and Loss Expense Reserve Development
<TABLE>
<CAPTION>
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997
-------- -------- -------- -------- ---------- ---------- ---------- ---------- ---------- ----------
(in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Gross liability
for unpaid
losses and loss
expenses......... $381,106 $616,611 $799,222 $957,344 $1,169,003 $1,359,701 $1,665,434 $1,920,500 $2,099,096 $2,342,254
Paid (cumulative)
as of:
One year later.. 517 98,519 141,863 103,970 163,086 138,072 188,370 299,465 233,162 199,066
Two years later. 23,285 240,207 169,656 266,191 296,213 326,610 487,264 531,694 409,818
Three years
later.......... 76,844 267,777 235,095 340,551 482,251 619,186 718,735 702,469
Four years
later.......... 87,639 296,095 258,589 432,506 688,064 806,140 843,046
Five years
later.......... 107,863 302,028 260,385 610,936 873,832 919,208
Six years later. 107,863 303,791 341,337 714,764 984,956
Seven years
later.......... 107,863 384,717 357,051 732,430
Eight years
later.......... 107,863 385,951 366,376
Nine years
later.......... 107,916 387,753
Ten years later. 107,970
Eleven years
later..........
Twelve years
later..........
Liability
re-estimated
as of:
End of year..... $381,106 $616,611 $799,222 $957,344 $1,169,003 $1,359,701 $1,665,434 $1,920,500 $2,099,096 $2,342,254
One year later.. 383,949 654,931 808,642 973,711 1,203,360 1,435,500 1,667,334 1,964,402 1,863,250 2,169,248
Two years later. 348,152 654,160 700,733 929,176 1,282,051 1,441,018 1,628,191 1,665,418 1,754,002
Three years
later.......... 329,403 587,758 557,782 876,071 1,270,410 1,485,101 1,468,588 1,605,576
Four years
later.......... 279,106 447,360 531,264 878,597 1,359,848 1,365,998 1,404,774
Five years
later.......... 159,117 434,326 465,605 967,410 1,325,166 1,356,523
Six years later. 107,863 444,213 479,940 959,363 1,304,338
Seven years
later.......... 107,863 452,662 475,136 953,289
Eight years
later.......... 107,863 459,023 512,601
Nine years
later.......... 108,063 507,510
Ten years later. 158,068
Eleven years
later..........
Twelve years
later..........
Redundancy
(deficiency).... 223,038 109,101 286,621 4,055 (135,335) 3,178 260,660 314,924 345,094 173,006
<CAPTION>
1998
----------
<S> <C>
Gross liability
for unpaid
losses and loss
expenses......... $3,121,739
Paid (cumulative)
as of:
One year later..
Two years later.
Three years
later..........
Four years
later..........
Five years
later..........
Six years later.
Seven years
later..........
Eight years
later..........
Nine years
later..........
Ten years later.
Eleven years
later..........
Twelve years
later..........
Liability
re-estimated
as of:
End of year..... $3,121,739
One year later..
Two years later.
Three years
later..........
Four years
later..........
Five years
later..........
Six years later.
Seven years
later..........
Eight years
later..........
Nine years
later..........
Ten years later.
Eleven years
later..........
Twelve years
later..........
Redundancy
(deficiency)....
</TABLE>
13
<PAGE>
The following table presents a reconciliation of beginning and ending
reserve balances for the periods indicated (in thousands):
Reconciliation of Unpaid Losses and Loss Expenses
<TABLE>
<CAPTION>
Year Ended November 30,
----------------------------------
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Unpaid losses and loss expenses at
beginning of period....................... $2,342,254 $2,099,096 $1,920,500
Losses and loss expenses incurred in
respect of losses occurring in:
Current year............................. 713,059 735,313 436,334
Prior years.............................. (164,158) (260,407) 14,465
---------- ---------- ----------
Gross losses incurred...................... 548,901 474,906 450,799
Interest (paid) incurred on experiences
reserves.................................. 1,798 886 1,752
Portfolio transfer (assumption of reserves
with acquisitions)........................ 595,261 34,593 28,687
Losses and loss expenses paid in respect of
losses occurring in:
Current year............................. 167,409 34,055 3,177
Prior years.............................. 199,066 233,172 299,465
---------- ---------- ----------
Gross paid losses.......................... 366,475 267,227 302,642
---------- ---------- ----------
Unpaid losses and loss expenses at end of
period.................................... 3,121,739 2,342,254 2,099,096
========== ========== ==========
</TABLE>
Gross case and loss expense reserves as a component of total gross reserves
in 1998 increased to $1.4 billion from $863 million after the payment of $366
million in losses. One of the main reasons for the increase relates to the
acquisition of Mid Ocean and its related reserves. The case reserves for the
reinsurance operations at November 30, 1998 were $318 million compared to $27
million at the beginning of the year. Included in these reserves was $63
million established in respect to hurricane Georges and the SwissAir airline
disaster. One of the contributing factors to the reduction in prior losses was
the related reduction in loss reserves that were acquired with Mid Ocean. The
balance of the change is not attributable to any single or group of related
events, but to normal attrition as losses have developed over time into the
Company's layers of exposure, consistent with the nature of excess casualty
insurance.
The 1998 current year losses reflect the inclusion of the operations of Mid
Ocean acquired on August 7, 1998. The results include four months of XLMORe
and three months of Brockbank. These operations incurred $169 million in gross
losses for the reported period. These losses were largely attributable to
Hurricane Georges and the SwissAir airline disaster. 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 in part, by the release of
insurance reserves established for the Company's professional lines. These
reserves were reduced in accordance with 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. These policies were for a three-year period, written on a claims made
basis and expired in 1998.
Due to the nature of the Company's general liability policy form and the
level of coverage provided, with limits up to $200 million, 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 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."
14
<PAGE>
Claims Administration
All claims management activities are conducted by each insurance subsidiary
of the Company at such subsidiary's offices. Claims management 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.
Claims arising from contracts written by the Company's reinsurance
subsidiaries are managed in Bermuda by their own claims departments. 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. The claims handled by the Singapore branch are done in a similar
manner at that location.
Claims in respect of business written by corporate syndicate 1209 and
XLMORe's London branch are entered into a claims database maintained at each
location. 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, 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. The claims
departments 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 Insurance Services ("Admiral") at two
tele-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
in-house engineering team. Personal injury cases are handled by a team of in-
house specialists who, where necessary, appoint attorneys from a preferred
panel.
Investments
The Finance Committee of the Board of the Company 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 policy is based on a total return strategy and seeks to
maximize investment income through a high-quality, diversified portfolio while
focusing on preserving principal and maintaining liquidity. In this regard, at
November 30, 1998, the Company's fixed income investment portfolio included
U.S. and non-U.S. sovereign government obligations, corporate bonds and other
securities, 58% 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 generally do not restrict 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. The Company's U.S.
insurance subsidiaries and Brockbank are subject to restrictions on investment
prescribed by laws applicable to such operations. At each of November 30,
1998, 1997 and 1996, 11%, 19% and 14% of the Company's investments in fixed
maturity and short-term investments and 34%, 42% and 45% of the Company's
investments in equity securities were represented by securities of non-U.S.
issuers. The Company did not have an aggregate investment in a single entity
(other than the U.S. government) in excess of 10% of total consolidated
shareholders' equity at November 30, 1998, 1997 or 1996.
15
<PAGE>
The following table reflects investment results for the Company for each of
the five years in the period ended November 30, 1998:
<TABLE>
<CAPTION>
Net Pre-Tax
Pre-Tax Realized Annualized
Average Investment Gains Effective
Year Ended November 30, Investments(1) Income(2) (Losses) Yield
----------------------- -------------- ---------- -------- ----------
(dollars in thousands)
<S> <C> <C> <C> <C>
1998...................... $5,323,308 $279,375 $191,795 5.25%
1997...................... 4,125,244 216,552 335,939 5.25
1996...................... 3,888,001 198,598 206,212 5.11
1995...................... 3,559,454 200,145 49,774 5.62
1994...................... 3,267,286 182,262 (95,197) 5.58
</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 realized net capital gains (losses).
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 the 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 (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 (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 (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, Trade and Employment.
16
<PAGE>
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, including requirements as to premium rates and
policy forms, adequacy of reserves, types and quality of investments,
dividends and changes of control. Any entity wishing to acquire more than 10
percent 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 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
licensed in California as a surplus and special 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 generally its subsidiaries 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, "effects and carries
on" business in the United Kingdom and is therefore regulated by the UK FSA.
Lloyd's
As a result of the Company's ownership of Brockbank, the Company and
Brockbank 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 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 a 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% or 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.
17
<PAGE>
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
The Company is subject to regulation in Australia, Singapore and Germany as
a result of its 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
Corporate Income Tax
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 CCVs are subject to
this arrangement but, as UK 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.
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 and Germany. 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 November 30, 1998, the Company and its subsidiaries employed a total of
506 employees; of which 181 were located in Bermuda, 261 were located in the
United Kingdom, 43 in the Republic of Ireland, 6 in the United States with the
balance located in the Company's offices in Munich and Singapore. None of the
these employees are represented by a labor union, and the Company believes
that its employee relations are excellent.
18
<PAGE>
Item 2. Properties
The Company rents space for its principal executive offices under leases
which expire up to June 2009. Total rent expense for the years ended November
30, 1998, 1997 and 1996 were approximately $3.7 million, $2.1 million and $1.8
million, respectively. Future minimum rental commitments under existing leases
are expected to be approximately $4.0 million annually. 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 $23.7 million has been spent to date.
It is estimated that the headquarters project will be completed early 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 in the normal course
of its business. Although most of its insurance policies provide for
resolution of disputes by arbitration in London, XLI has been sued several
times in United States courts and is defending each suit vigorously, both on
procedural grounds and the merits. As of November 30, 1998, the Company was
not a party to any material litigation 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 have been 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 v.
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 judgment (due to their alleged
conflict of interest) and by agreeing to sell Mid Ocean at an unfair and
inadequate price. The Shareholder Action is 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 plaintiff's 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 conveniens). 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 November 30,
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 Executive 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 President 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, General Counsel and Secretary 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 of XLI from
December 1995, having previously served as Executive Vice President and Chief
Underwriting Officer of XLI from 1992, and as a Senior Vice President from
1987.
Henry C. V. Keeling has been Executive Vice President of the Company and
President 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 and is a director and the Chief Executive Officer of Brockbank.
Mr. Brockbank has been employed at Lloyd's since 1974 when he joined Willis
Faber Dumas as a marine broker. He was an underwriter of syndicate 861 from
1983 through to 1998. 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.
20
<PAGE>
Christopher V. Greetham has been an Executive Vice President of the Company
since December 1998 and has served as its Chief Investment Officer since 1996.
From 1996 until December 1998, Mr. Greetham was a Senior Vice President of the
Company. 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 and XLI since January 1997. Mr. Giordano was appointed Secretary of
the Company and XLI on December 31, 1997. Mr. Giordano was appointed Senior
Vice President, General Counsel and Secretary of XLMORe in August 1998. 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, adjusted for the one-for-one
stock dividend on July 26, 1996.
<TABLE>
<CAPTION>
High Low
------- -------
<S> <C> <C>
1997:
1st Quarter............................................. $45.000 $36.500
2nd Quarter............................................. 44.500 39.000
3rd Quarter............................................. 57.500 44.500
4th Quarter............................................. 64.000 55.063
1998:
1st Quarter............................................. $66.688 $59.063
2nd Quarter............................................. 80.813 66.938
3rd Quarter............................................. 83.250 66.813
4th Quarter............................................. 77.688 62.125
</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 ten percent (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 November 30, 1998 was 360.
(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 shareholders
of record on February 6, April 16 and July 15 and one of $0.44 per share to
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, the
capital and surplus requirements of the Company's operating subsidiaries and
regulatory considerations.
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 insurance laws and
regulations of Bermuda, the United States and the United Kingdom, including
those promulgated by the Society of Lloyd's. 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 November 30, 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 material
subsidiaries other than XLI, XLMORe, XLE, XLIA or XLRS had any other
restrictions preventing them from paying dividends. No assurance, however, can
be given that the Company or its subsidiaries will not be prevented from
paying 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 outstanding Class A Ordinary Share
held of record as of the close of business on October 31, 1998. Each
22
<PAGE>
Right will entitle holders of XL Class A Ordinary Shares to buy one ordinary
share at an exercise price of $350.00. The Rights would be exercisable, and
would detach from the Class A Ordinary Shares, only if a person or group were
to acquire 20 percent or more of XL's outstanding Class A Ordinary Shares, or
were to announce a tender or exchange offer that, if consumated, would result
in a person or group beneficially owning 20 percent or more of XL's Class A
Ordinary Shares. Upon a person or group without prior approval of the Board
acquiring 20 percent 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 the 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.
Item 6. Selected Financial Data
The selected consolidated financial data below should be read in conjunction
with the consolidated financial statements and the notes thereto presented
under Item 8.
<TABLE>
<CAPTION>
1998 1997 1996 1995 1994
---------- ---------- ---------- ---------- ----------
(in thousands of U.S. dollars, except per share
amounts and ratios)
<S> <C> <C> <C> <C> <C>
Income Statement Data:
Gross premiums
written.............. $ 806,861 $ 441,290 $ 729,446 $ 698,020 $ 638,294
Net premiums written.. 672,044 316,626 597,102 694,337 627,987
Net premiums earned... 685,200 540,653 517,892 558,049 521,177
Net investment income. 279,375 216,552 198,598 200,145 182,262
Net realized gains
(losses)............. 191,795 335,939 206,212 49,774 (95,197)
Equity in net income
of affiliates........ 47,980 65,882 59,249 51,074 25,028
Losses and loss
expenses............. 390,483 365,325 405,357 440,922 407,172
Acquisition costs and
administration
expenses............. 197,864 98,665 79,476 83,602 81,219
Interest expense...... 11,523 7,176 -- -- --
Amortization of
intangible assets.... 23,926 5,844 -- -- --
Income before minority
interest and income
tax expense.......... 593,852 682,016 497,118 334,518 144,879
Net income............ 587,663 676,961 494,313 332,798 143,954
Net income per share--
basic (1)(2)......... $ 6.32 $ 7.95 $ 5.45 $ 3.24 $ 1.33
Net income per share--
diluted (1)(2)....... $ 6.20 $ 7.84 $ 5.41 $ 3.22 $ 1.32
Weighted average
shares outstanding--
basic (2)............ 92,975 85,120 90,734 102,652 108,176
Weighted average
shares outstanding--
diluted (2).......... 94,785 86,314 91,328 103,296 108,676
Cash dividends per
share (2)............ $ 1.64 $ 1.36 $ 0.95 $ 0.71 $ 0.62
Balance Sheet Data:
Total investments..... $6,462,396 $4,254,668 $3,772,976 $3,355,295 $2,943,712
Cash and cash
equivalents.......... 443,654 394,599 252,734 673,433 456,176
Investment in
affiliates........... 154,044 517,396 414,891 351,669 230,852
Total assets.......... 10,108,650 6,088,462 5,031,538 4,721,466 3,853,152
Unpaid losses and loss
expenses............. 3,121,739 2,342,254 2,099,096 1,920,500 1,665,434
Loans payable......... 301,000 141,000 11,000 -- --
Shareholders' equity.. 4,817,880 2,479,130 2,116,038 2,006,133 1,684,393
Book value per share
(2).................. $ 43.09 $ 29.37 $ 24.27 $ 21.22 $ 15.73
Fully diluted book
value per share (2).. $ 42.79 $ 29.33 $ 24.21 $ 21.11 $ 15.73
Operating Ratios:
Loss and loss expense
ratio................ 57.0% 67.6% 78.3% 79.0% 78.1%
Underwriting expense
ratio................ 26.3 18.2 15.3 15.0 15.6
Combined ratio........ 83.3 85.8 93.6 94.0 93.7
</TABLE>
23
<PAGE>
- --------
(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 shareholders of record
on July 26, 1996.
Item 7. Management's Discussion and Analysis of Results of Operations and
Financial Condition
Results of Operations for the Years Ended November 30, 1998, 1997 and 1996
The following is a discussion of the Company's results of operations and
financial condition. This discussion and analysis should be read in
conjunction with the audited Consolidated Financial Statements and notes
thereto presented under Item 8.
The following table presents an analysis of the Company's revenues for the
years ended November 30, 1998, 1997 and 1996 (U.S. dollars in thousands):
<TABLE>
<CAPTION>
1998 Change 1997 Change 1996
---------- ------ ---------- ------ --------
<S> <C> <C> <C> <C> <C>
Net premiums earned.............. $ 685,200 26.7% $ 540,653 4.4% $517,892
Net investment income............ 279,375 29.0% 216,552 9.0% 198,598
Net realized gains............... 191,795 NM 335,939 NM 206,212
Equity in net earnings of
affiliates...................... 47,980 (27.2)% 65,882 11.2% 59,249
Fee and other income............. 13,298 NM -- NM --
---------- ---------- --------
$1,217,648 $1,159,026 $981,951
========== ========== ========
</TABLE>
Both net earned premiums and net investment income increased significantly
in 1998 over 1997, compared to the change from 1996 to 1997. These results
were affected by the Company's acquisition of GCR in June 1997 and the merger
with Mid Ocean in August 1998. Accordingly, such growth may not be indicative
for future periods.
Mid Ocean prior to the acquisition was an affiliate of the Company.
Consequently, the equity in net earnings from affiliates only reflects the
Company's share of Mid Ocean's earnings for the first nine months of 1998.
Subsequent results for Mid Ocean are now consolidated.
The Company is effectively organized into three business operations:
insurance, reinsurance and Lloyd's Syndicates.
The insurance business is written primarily by XLI, based in Bermuda, and
its subsidiaries, XLE, based in Dublin, Ireland, XLIA and XLRS, based in New
York and Connecticut, respectively. The insurance operations are leading
providers of high excess coverage for general third party liability, other
liability, including directors and officers, professional and employment
practices liability, property and other specialty covers.
The reinsurance business is written primarily by XLMORe, based in Bermuda,
with branch operations in London and Singapore and an office in Munich. It
also has controlling ownership of LARe. MORe, a subsidiary of Mid Ocean, was
acquired by merger on August 7, 1998, and was amalgamated with XLGRe. The
reinsurance group is a leading writer of property catastrophe, other property,
including property excess of loss and property pro rata, marine and energy,
aviation and satellite and specialty liability and other covers.
The Lloyd's operations are managed by Brockbank which 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 of insurance
but also reinsurance, to a globally diverse group of clients. The Brockbank
operations were acquired through the merger with Mid Ocean. The results of
Brockbank are only included in the Company's 1998 fourth quarter. Premiums
written for the first nine months relate to the Company's interest in Venton
Holdings Limited ("Venton"). The Company's interest in Venton was sold in the
fourth quarter of the Company's 1998 fiscal year.
24
<PAGE>
Premiums
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
(in thousands)
<S> <C> <C> <C>
Gross premiums written
Insurance Operations
General liability............................... $185,081 $252,790 $432,002
Other liability................................. 161,423 127,321 111,892
Property........................................ 35,567 38,261 40,691
Other........................................... 42,213 -- --
Reinsurance Operations
Property catastrophe............................ 89,084 (78,331) 64,130
Other property.................................. 29,014 17,069 2,111
Marine and energy............................... 26,169 17,797 20,931
Aviation and satellite.......................... 37,602 37,470 13,433
Other........................................... 79,909 28,913 44,256
Lloyd's Syndicates............................... 120,799 -- --
-------- -------- --------
806,861 441,290 729,446
Multi-year premiums............................... (26,433) 115,645 (164,033)
-------- -------- --------
$780,428 $556,935 $565,413
======== ======== ========
Net premiums written
Insurance Operations
General liability............................... $136,095 $150,816 $319,745
Other liability................................. 152,491 116,230 101,818
Property........................................ 24,822 29,367 30,678
Other........................................... 36,875 -- --
Reinsurance Operations
Property catastrophe............................ 76,549 (78,940) 64,130
Other property.................................. 25,335 17,068 2,111
Marine and energy............................... 24,714 17,797 20,931
Aviation and satellite.......................... 37,332 37,470 13,433
Other........................................... 75,029 26,818 44,256
Lloyd's Syndicates............................... 82,802 -- --
-------- -------- --------
672,044 316,626 597,102
Multi-year premiums............................... (22,116) 122,762 (129,432)
-------- -------- --------
$649,928 $439,388 $467,670
======== ======== ========
Net premiums earned
Insurance Operations
General liability............................... $178,735 $263,543 $325,777
Other liability................................. 95,166 91,364 80,427
Property........................................ 23,273 21,264 20,622
Other........................................... 5,124 -- --
Reinsurance Operations
Property catastrophe............................ 122,199 40,892 26,927
Other property.................................. 42,247 16,581 419
Marine and energy............................... 31,068 20,420 21,536
Aviation and satellite.......................... 44,033 36,421 7,256
Other........................................... 70,478 50,168 34,928
Lloyd's Syndicates............................... 72,877 -- --
-------- -------- --------
$685,200 $540,653 $517,892
======== ======== ========
</TABLE>
25
<PAGE>
The growth in gross and net premiums written and net premiums earned have
been affected by the Company's acquisitions (as discussed previously), the
development of new product lines and the ability to maintain a relatively high
level of policy retention despite the highly competitive environment that the
Company and its subsidiaries operate in.
The increase in gross premiums written of $356.6 million in 1998 compared to
1997 was caused by several factors. The level of multi-year premiums written
increased in 1998 compared a decline in such business in 1997. The 1997 fiscal
year was negatively affected by several multi-year property catastrophe
contracts which were rewritten during the year resulting in the return of
premiums written for future years that had not yet been collected or earned.
This also resulted in a reduction of premiums receivable and unearned
premiums.
Additionally, as previously mentioned, the growth in gross premiums written
was affected by the acquisitions of GCR and Mid Ocean. The 1998 year includes
a full year of GCR's premiums compared to five and a half months in 1997, plus
four months of Mid Ocean results and three months of Brockbank results. The
GCR and Mid Ocean premiums are included under Reinsurance Operations and the
Brockbank premiums are included under Lloyd's Syndicates.
Property catastrophe premiums through the first nine months of 1998 reflect
business assumed primarily by XLGRe prior to its amalgamation with MORe while
premiums thereafter reflect the combined MORe and XLGRe. Other reinsurance
represents specialty liability reinsurance related primarily to tailored
programs written by XLI.
Premiums written by Lloyd's Syndicates for the first nine months of the
year, approximately $25 million gross and $7 million net, relate solely to the
Company's interest in Venton. As mentioned previously, Venton was sold in the
fourth quarter of 1998. Accordingly, all results from Lloyd's Syndicates from
the fourth quarter of 1998 and forward are attributable to Brockbank.
Gross premiums written in 1998 and 1997 were also affected by a significant
decline in premiums written for general liability insurance. The Company
continues to experience high levels of competition, particularly on a price
basis and coverage terms, although business retention has remained in excess
of 80%. Policy retention for general liability insurance was 86.1% in 1998
compared to 80.1% in 1997 and 87.9% in 1996. 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. As at November 30, 1998, the
average limits for general liability insurance was $84.4 million in excess of
$135.2 million attachment point, as compared to average limits of $86.4
million and $80.2 million in excess of attachment points of $104.0 million and
$78.7 million for the years ended November 30, 1997 and 1996, respectively.
Other liability insurance (comprising mostly professional lines), increased
significantly primarily as a result of several tailored multi-year programs
written in the year. These transactions tend to be complex in nature and often
take a significant period of time to structure, thus premiums written in any
given year may not be representative of future years and/or may be irregular
in nature.
The growth in net premiums written (gross premiums net of reinsurance ceded)
in 1998 over 1997 was likewise affected by the above mentioned factors. In
addition, the Insurance Operations purchased general liability excess of loss
reinsurance contract for $33.8 million at the beginning of the Company's 1997
fourth quarter resulting in a reduction of net premiums written. Such
reinsurance was extended to the Company's year end and has been renewed for
1999. There was no equivalent reinsurance for 1996.
26
<PAGE>
The increase in net premiums earned reflects the corresponding growth in net
premiums written. Unlike net premiums written, the timing differences created
by the writing of multi-year premiums are smoothed as net premiums are earned
over the lives of the policies. Thus net earned premiums earned may give a
better indication of the trends in the Company's underlying business.
Net Investment Income
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
(in thousands)
<S> <C> <C> <C> <C> <C>
Net investment income........................ $279,375 $216,552 $198,598
</TABLE>
The increase in net investment income in 1998 over 1997 is due to a number
of factors. The average asset base increased primarily due to the merger with
Mid Ocean during the third quarter of 1998 and the Company's positive
operational cash flow. In addition, the average yield of the portfolio was
higher due to a widening of interest spreads and a decrease in the
proportionate amount of equity securities held as a percentage of the total
investment portfolio.
Similarly, in 1997, the average asset base increased with the acquisition of
GCR. Average investment yields were also higher than 1996. The proportion of
equity securities relative to the fixed income portfolio decreased marginally
in 1997 compared to 1996.
Net Realized Investment Gains
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
(in thousands)
<S> <C> <C> <C>
Net realized investment gains....................... $191,795 $335,939 $206,212
</TABLE>
Gains realized in 1998 reflected the strong performance of both the equity
and certain sectors of the fixed income markets early in 1998, offset by
dramatic price declines in the third quarter, followed by recoveries in the
fourth quarter. Regarding the latter, generally declining interest rates and
sector volatility have resulted in spreads widening in the corporate and
mortgage markets, thereby providing 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 with a goal of generating
investment gains in the process.
The equity markets world-wide have remained strong but also have been
subject to greater volatility through the year. This resulted in $136.7
million in gains being realized as some of the Company's equity managers
locked in gains where they felt valuations had reached their targets. The
Company also sold its minority investment in Venton during the fourth quarter,
realizing a $14.1 million gain.
During 1997, both the fixed income and equity portfolios were restructured,
resulting in 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 $25.8 million and
$37.4 million for the years ended November 30, 1998 and 1997, respectively.
Equity in Net Income of Affiliates
<TABLE>
<CAPTION>
1998 1997 1996
------- ------- -------
(in thousands)
<S> <C> <C> <C>
Equity in net income of affiliates..................... $47,980 $65,882 $59,249
</TABLE>
Equity in net income from 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 nine
months of earnings were accounted for on this basis in 1998, compared to a
full year in 1997.
27
<PAGE>
The increase in equity in net income of affiliates in 1997 over 1996
reflected 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. No positive contributions were recorded
from these affiliates in 1998.
Fee and Other Income
<TABLE>
<CAPTION>
1998 1997 1996
------- ---- ----
(in thousands)
<S> <C> <C> <C>
Fee and other income.......................................... $13,298 -- --
</TABLE>
Approximately one half of all fee income represents net managing agency
income for fees earned by Brockbank and are only for one reported quarter in
1998. These fees are received from the management of Lloyd's syndicates, and
profit commissions are earned under GAAP based upon estimated results of the
syndicates managed. Profit commissions are settled and paid to the managing
agent after an underwriting year has been closed under Lloyd's rules, which is
normally three years after its inception.
Of the remaining balance, $2.2 million represents a fee to the Company's
insurance operations for structuring a specialty insurance cover and $3.6
million represents a distribution from one of its limited partnership
investments.
Combined Ratio
<TABLE>
<CAPTION>
1998 1997 1996
----- ----- -----
<S> <C> <C> <C>
Loss and loss expense ratio................................... 57.0% 67.6% 78.3%
Underwriting expense ratio.................................... 26.3% 18.2% 15.3%
----- ----- -----
Combined ratio................................................ 83.3% 85.8% 93.6%
===== ===== =====
</TABLE>
The decrease in the loss ratio primarily reflects the diversification of the
Company's business over the past two years to include a lower proportion of
liability business, which tends to be long-tail in nature. Loss ratios for
this longer tail business can be higher but usually pay out claims over
several years. The Company experienced lower losses in shorter tail lines
resulting in an overall lower loss ratio. The decrease in the proportion of
longer tail business will cause overall Company loss ratios to decrease in
periods of low catastrophic activity. It should also be noted that the
converse may also occur.
The 1998 year reflects a full year of the results of GCR acquired in June
1997 and four months of MORe acquired in August 1998. Most of the business
written by these companies is short tail in nature.
The 1998 loss ratio was also 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 take a conservative stance with respect to initial reserves,
particularly on new lines of business due to the limited loss development the
Company would have experienced to date and the long tail nature of certain
lines of cover. In addition, reserves were reduced on specialty cover policies
for the years 1995 through 1997 due to the absence of losses on these
policies. These policies were for a three-year period, written on a claims
made basis, and expired in 1998.
During the fourth quarter of 1998 the Company incurred reinsurance losses of
$63 million relating to Hurricane Georges and the SwissAir airline disaster.
These losses were offset in part by reserves accrued during the year that were
transferred to the Company through the merger with Mid Ocean.
Prior to the acquisition of GCR, reinsurance business was not a significant
component of the Company's total book of business. As the relative proportion
of this business increased, the loss ratio decreased for the reasons explained
above resulting in a lower loss ratio in 1997 over 1996.
28
<PAGE>
The increase in the expense ratio reflects the change in the Company's
business mix. The reinsurance and Lloyd's syndicate businesses typically have
higher acquisition costs than the Company's insurance business.
The underwriting expense ratio excludes interest costs, the amortization of
intangible assets and one time charges totaling $17.5 million associated with
the realignment of the Company's reinsurance systems and operations. XLGRe and
MORe were amalgamated in August 1998, requiring the merging of data from two
different underwriting systems to effectively monitor the spread of geographic
and other risks. This also required the conversion of all the contracts on one
system to the other. Duplicate office facilities were closed and their
associated capitalized costs were expensed. The Company's severance costs
relating to redundant staff were expensed as well as certain professional
expenses incurred in connection with the merger.
Net Income
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
(in thousands except per
share amounts)
<S> <C> <C> <C>
Income excluding net realized gains on
investments, amortization of intangible assets
and one time realignment charges................ $437,254 $346,866 $288,101
Net realized gains............................... 191,795 335,939 206,212
Amortization of intangible assets................ (23,926) (5,844) --
Alignment charges................................ (17,460) -- --
-------- -------- --------
Net income....................................... $587,663 $676,961 $494,313
======== ======== ========
Earnings per share--basic........................ $ 6.32 $ 7.95 $ 5.45
======== ======== ========
Earnings per share--diluted...................... $ 6.20 $ 7.84 $ 5.41
======== ======== ========
</TABLE>
Net income for 1998 decreased over 1997 which had increased over 1996
primarily due to the amount of investment gains realized in 1997 compared to
1998 and 1996. The increase in income before realized gains and the other
disclosed charges in 1998 and 1997 reflect the Company's acquisitions of Mid
Ocean on August 7, 1998 and GCR on June 12, 1997. Earnings per share were also
affected by the weighted average number of shares outstanding. On a diluted
basis, these were 94,785,000 shares for 1998, 86,314,000 shares for 1997 and
91,328,000 for 1996. The decrease in the weighted average number of shares
outstanding in 1997 reflects the repurchase of shares in 1996 and 1997. The
increase in the number of shares for 1998 is primarily due to the issue of
shares in exchange for Mid Ocean Limited shares.
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, rules and regulations of Bermuda, the United States,
the Republic of Ireland and the United Kingdom insurance law and regulations,
including those promulgated by the Society of Lloyd's. 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 November 30,
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 material subsidiaries other than XLI, XLMORe, XLE, XLIA and XLRS had any
other restrictions preventing them from paying dividends. No assurance,
however, can be given that the Company or its subsidiaries will not be
prevented from paying dividends in the future. The Company's shareholders'
equity at November 30, 1998 was $4.8 billion, of which $2.4 billion was
retained earnings.
At November 30, 1998, total investments and cash net of unsettled investment
trades was $6.4 billion, compared to $4.3 billion at November 30, 1997. The
increase is due to the acquisition of cash and investments included in the
merger with Mid Ocean, as well as the reinvestment of investment income and
realized gains and
29
<PAGE>
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 increased exposure to events which occurred in prior years but have not
yet been reported or paid. It is also possible that funds available for
investment will be reduced as compared to prior years due to potential
increased claims payments. The Company's fixed income investments (including
short-term investments and cash equivalents) at November 30, 1998 represented
approximately 83% of invested assets and were managed by several outside
investment managers with different strategies. Of the fixed income securities,
83% are of investment grade, with 58% rated Aa or AA or better by a nationally
recognized rating agency. The average quality of the fixed income portfolio
was AA-.
The payable for investments purchased has increased from $382.3 million at
November 30, 1997 to $526.4 million at November 30, 1998. This increase
results from timing differences as it is the Company's policy to account for
its investments on a trade basis.
In fiscal 1996, 1997 and 1998, the total amount of losses paid by the
Company was $302.6 million, $267.2 million and $366.5 million respectively.
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 exceeding
applicable minimum attachment points. 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. In addition, the Company from time to time evaluates whether minimum
attachment points should be raised to take into account inflationary factors.
The Company commenced its initial stock repurchase program in September 1993
as authorized by its Board of Directors and obtained approval for subsequent
programs as each program was completed. On January 24, 1997, the Board of
Directors authorized the Company to repurchase 3 million shares as
circumstances warrant. As at November 30, 1997, the Company had purchased
595,000 shares at cost of $25.3 million. On March 13, 1998, the Board of
Directors discontinued this program with 2.4 million shares remaining and
replaced it with an authorization to repurchase $500 million of its shares. Of
this amount, $300 million was used to repurchase 3.7 million shares related to
the merger with Mid Ocean. In addition, the Company had purchased a further
732,000 shares at a cost of $51.2 million during the year. On January 22,
1999, the Board of Directors discontinued this program with $148.8 million
remaining and replaced it with an authorization to repurchase $500 million of
its shares.
On June 11, 1997, subsidiaries of the Company obtained two revolving lines
of credit each for $250 million, one for 364 days and the other for 5 years.
The one-year facility has been extended until June 1999. These facilities are
provided by a syndicate of banks in order to facilitate strategic acquisitions
and to supplement operational cash flow. The weighted average interest rate on
the funds borrowed during 1998 was 5.667%. The balance of the loan outstanding
under the facilities as at November 30, 1998 was $190 million, which was
extended for an additional three months at its due date on December 16, 1998.
This amount represents the balance remaining of $250 million that was borrowed
to fund the cash election option available to shareholders in connection with
the Mid Ocean merger.
Mid Ocean had obtained multi-currency committed lines of credit provided by
a syndicate of banks which provides for unsecured borrowing up to an aggregate
amount of $200 million subject to certain conditions in
30
<PAGE>
August 1997. The Mid Ocean facility is split evenly between a 364-day and a
5-year facility. These facilities remained in place following the merger with
Mid Ocean. In August 1998, $50 million was borrowed from the 5-year facility
and used by the Company in connection with the purchase of shares as part of
the Mid Ocean merger. This was repaid in November 1998.
In 1998, X.L. America, Inc. ("XLA") obtained an unsecured revolving line of
credit of $100 million for 364 days from a U.S. bank. During the year the full
amount of this facility was borrowed and used to fund the Company's U.S.
operations. This line of credit was replaced in December 1998 with a $150
million commercial paper funding facility of which $100 million has been
drawn. XLI guarantees the indebtedness of XLA under this facility.
On February 27, 1998, subsidiaries of the Company obtained a $500 million
letter of credit facility from a syndicate of banks, which is secured against
the Company's investment portfolio. This facility is used to collateralize
certain reinsured's technical reserves with the Company. The Company has
committed to letters of credit of approximately $80.6 million as at November
30, 1998.
Mid Ocean had a $325 million letter of credit facility with Citibank N.A.,
London Branch, which is secured against its investment portfolio. Letters of
credit totaling approximately $223.0 million under this facility were
outstanding as at November 30, 1998.
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.
The Company has 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
November 30, 1998 the remediation and validation efforts are approximately 50%
complete, with the costs through such date aggregating approximately $3
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.
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 nor 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 issues.
31
<PAGE>
Financial Risk Management
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 methods used by the Company to assess and
mitigate risk should not be considered projections of future events of losses
or lack of losses.
The Company's investment portfolio consists of fixed income and equity
securities, denominated in both U.S. dollars and non-U.S. 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 4.6% or $246 million on the Company's
fixed income portfolio as of November 30, 1998.
The Company has short term debt outstanding. Interest rates are LIBOR based.
Accordingly, any changes in interest rates will affect interest expense. The
Company only has open positions on its five year facility. There are three and
a half years remaining before this facility must be renewed.
In evaluating the impact of price changes of the equity portfolio, including
the synthetic portion thereof, the annual volatility (standard deviation
adjusted to an immediate time horizon) of the S&P (Standard and Poor's) Index
and the Morgan Stanley EAFE (European Australia Far East) Index were used as
proxies for U.S. and non-U.S. securities, respectively. Based upon one
standard deviation, total return would be impacted by $12 million. A 10%
change in equity prices would effect total return by approximately $113
million.
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 non-U.S. dollar
fixed maturities and its non-U.S. dollar 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
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, a forward contract will not be entered into. At November
30, 1998, forward foreign exchange contracts with notional principal amounts
totaling $322.3 million were outstanding. The fair value of these contracts as
at November 30, 1998, was $308.4 million with unrealized losses of $13.9
million. Gains of $3.8 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 November 30, 1998 would have
resulted in approximately $11.2 million in unrealized gains and $33.2 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 non-U.S. dollar
investments. These contracts are not designated as specific hedges for
financial reporting purposes, and generally have maturities of weeks or less.
As such, any realized or unrealized gains or losses are recorded in income in
the period in which they occur. At November 30, 1998, the Company had $2.4
million of such contracts outstanding, and had recognized a total of $0.4
million in realized and unrealized losses for the twelve month period. 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 November 30, 1998,
would have had no material effect on income.
The Company attempts to hedge directly the foreign currency exposure of a
portion of its non-U.S. Dollar 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 November 30, 1998 the Company had, as hedges, foreign exchange
contracts for the sale of $17.5 million and the purchase of $0.1 million of
foreign currencies at fixed rates, primarily New Zealand Dollars (73% of net
contract value), Danish Kroner (14%) and Swedish Kroner (13%). The market
value of non-U.S. Dollar fixed maturities held by the Company as at November
30, 1998 was $19.0 million.
32
<PAGE>
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 November 30, 1998, unrealized deferred losses
amounted to $0.1 million, and were offset by corresponding decreases 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 November 30, 1998, realized
deferred losses amounted to $2.0 million.
In January 1999, eleven Member States of the European Union ("EU") began
their participation in the EU's Economic and Monetary Union pursuant to which
participating Member States currencies were converted into the Euro, the
common currency for the EU. The Company is uncertain as to the impact of the
conversion on its business and financial condition and the Company has not yet
initiated a detailed analysis and plan with respect to the Euro. Although the
Company does not anticipate the costs associated with the conversion to be
material, such costs are not known with precision at this time.
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 November 30, 1998, the portfolio
held $138.3 million in exposure to S&P 500 Index futures together with fixed
maturities, short-term investments and cash amounting to $139.5 million. Based
on this value, a 10% increase or decrease in the price of these futures would
have resulted in a total value, or exposure, of $152.2 million and $124.5
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
November 30, 1998, net realized gains from index futures totalled $25.8
million as a result of the 21.5% 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 November 30, 1998, bond and
stock index futures outstanding were $333.4 million, with underlying
investments having a market value of $2.1 billion (all portfolio managers are
prohibited by the Company's investment guidelines from leveraging their
positions). A 10% appreciation or depreciation of these derivative instruments
at this time would have resulted in unrealized gains and losses of $33.3
million, respectively.
Accounting Standards
The Financial Accounting Standards Board ("FASB") issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information",
effective for fiscal years beginning after December 15, 1997. This statement
established standards for reporting information about operating segments in
annual financial statements and requires selected information about operating
segments in interim financial reports issued to shareholders. It also
established standards for related disclosures about products and services,
geographical areas and major customers. Under SFAS 131, operating segments are
to be determined consistent with the way that management organizes and
evaluates financial information internally for making operating decisions and
assessing performance. The Company has not yet assessed the affect of the
adoption of this accounting standard on its consolidated financial statement
disclosures.
FASB issued SFAS No. 132, "Employers' Disclosures about Pensions and Other
Postretirement Benefits," effective for fiscal years beginning after December
15, 1997. This Statement revises employers' disclosures about pensions and
other postretirement benefit plans. This standard is expected to have a
minimal impact on the Company's consolidated financial disclosures.
FASB also issued SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities", effective for all fiscal quarters of fiscal years
beginning after June 15, 1999. This Statement establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts (collectively referred to as
derivatives), and for hedging activities. It requires that an entity recognize
all derivatives as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. If certain conditions
are met, a derivative may be specifically designated as a hedge.
33
<PAGE>
The accounting for changes in fair value of a derivative (that is, gains and
losses) depends on the intended use of the derivative and the resulting
designation. The Company has not yet assessed the affect of the adoption of
this accounting standard on its consolidated financial statement disclosures.
SFAS No. 131 and No. 133 are not expected to have a significant impact on the
Company's overall results but will affect the Company's financial statements
and disclosures.
Current Outlook
The Company believes competition in the property casualty insurance and
reinsurance industry will continue to be strong and may intensify in 1999,
exerting pressure on rates in general across virtually all property and
casualty product lines. Although the Company believes some opportunities will
exist in 1999 for growth in certain product lines, no assurances can be made
that growth in such product lines will be sufficient to offset the competitive
pressures affecting the Company's other 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; (v) developments
in the world's financial and capital markets which adversely affect the
performance of the Company's investments; (vi) changes in regulation or tax
laws applicable to the Company, its subsidiaries, brokers or customers; (vii)
acceptance of the Company's products and services, including new products and
services; (viii) changes in the availability, cost or quality of reinsurance;
(ix) changes in the distribution or placement of risks due to increased
consolidation of insurance and reinsurance brokers; (x) the impact of Year
2000-related issues on the Company's technology systems and underwriting
exposures; (xi) loss of key personnel; (xii) the effects of mergers,
acquisitions and divestitures; (xiii) changes in rating agency policies or
practices; (xiv) changes in accounting policies or practices; and (xv) changes
in general economic conditions, including inflation, foreign currency exchange
rates, the introduction of the Euro and other factors. The foregoing review of
important factors should not be construed as exhaustive and should be read in
conjunction with 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.
Item 8. Financial Statements and Supplementary Data
<TABLE>
<CAPTION>
Index to Consolidated Financial Statements and Related Notes Page
- ------------------------------------------------------------ ----
<S> <C>
Consolidated Balance Sheets as of November 30, 1998 and 1997.............. 35
Consolidated Statements of Income for the years ended November 30, 1998,
1997 and 1996............................................................ 36
Consolidated Statements of Shareholders' Equity for the years ended
November 30, 1998, 1997 and 1996......................................... 37
Consolidated Statements of Cash Flows for the years ended November 30,
1998, 1997 and 1996...................................................... 38
Notes to Consolidated Financial Statements for the years ended November
30, 1998, 1997 and 1996.................................................. 39
Independent Auditors' Report.............................................. 62
</TABLE>
34
<PAGE>
XL CAPITAL LTD
CONSOLIDATED BALANCE SHEETS AS AT NOVEMBER 30, 1998 AND 1997
(Expressed in thousands of U.S. dollars)
<TABLE>
<CAPTION>
ASSETS 1998 1997
------ ----------- ----------
<S> <C> <C>
Investments available for sale:
Fixed maturities, available for sale at fair value
(amortized cost:
1998--$5,197,246; 1997--$3,144,642)................ $ 5,212,581 $3,196,872
Equity securities, at fair value (cost: 1998--
$995,873; 1997--$729,888).......................... 1,128,601 837,827
Short-term investments, at fair value (amortized
cost: 1998--$121,177;
1997--$220,138).................................... 121,214 219,969
----------- ----------
Total investments available for sale.............. 6,462,396 4,254,668
Cash and cash equivalents............................. 443,654 394,599
Investment in affiliates (cost: 1998--$140,201; 1997--
$336,680)............................................ 154,044 517,396
Other investments..................................... 41,369 27,244
Accrued investment income............................. 59,699 48,576
Deferred acquisition costs............................ 97,951 22,272
Prepaid reinsurance premiums.......................... 141,385 108,916
Premiums receivable................................... 689,516 254,238
Reinsurance balances receivable....................... 388,954 156,025
Intangible assets..................................... 1,500,404 267,695
Other assets.......................................... 129,278 36,833
----------- ----------
Total assets...................................... $10,108,650 $6,088,462
=========== ==========
<CAPTION>
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
<S> <C> <C>
Liabilities:
Unpaid losses and loss expenses....................... $ 3,121,739 $2,342,254
Unearned premiums..................................... 1,010,907 566,911
Premiums received in advance.......................... 19,167 40,706
Accounts payable and accrued liabilities.............. 143,529 40,923
Reinsurance premiums payable.......................... 121,291 69,305
Loans payable......................................... 301,000 141,000
Net payable for investments purchased................. 526,357 382,345
Minority interest..................................... 46,780 25,888
----------- ----------
Total liabilities................................. $ 5,290,770 $3,609,332
----------- ----------
Shareholders' Equity:
Class A ordinary shares (par value $0.01; authorized,
999,990,000 shares including Class B shares; issued
and outstanding, 108,688,081 shares and 84,407,638
shares at November 30, 1998 and 1997, respectively).. 1,087 844
Class B ordinary shares (par value $0.01; authorized,
999,990,000 shares including Class A shares; issued
and outstanding, 3,115,873 shares and nil shares at
November 30, 1998 and 1997 respectively)............. 31 --
Contributed surplus................................... 2,289,456 290,085
Net unrealized appreciation on investments............ 159,953 188,444
Deferred compensation................................. (18,104) (11,362)
Retained earnings..................................... 2,385,457 2,011,119
----------- ----------
Total shareholders' equity........................ $ 4,817,880 $2,479,130
----------- ----------
Total liabilities and shareholders' equity........ $10,108,650 $6,088,462
=========== ==========
</TABLE>
See accompanying notes to Consolidated Financial Statements
35
<PAGE>
XL CAPITAL LTD
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED NOVEMBER 30, 1998, 1997 AND 1996
(Expressed in thousands of U.S. dollars, except per share amounts)
<TABLE>
<CAPTION>
1998 1997 1996
--------- --------- --------
<S> <C> <C> <C>
Revenues:
Net premiums earned............................ $ 685,200 $ 540,653 $517,892
Net investment income.......................... 279,375 216,552 198,598
Net realized gains on sales of investments..... 191,795 335,939 206,212
Equity in net income of affiliates............. 47,980 65,882 59,249
Fee and other income........................... 13,298 -- --
--------- --------- --------
Total revenues............................... 1,217,648 1,159,026 981,951
--------- --------- --------
Expenses:
Losses and loss expenses....................... 390,483 365,325 405,357
Acquisition costs.............................. 88,596 46,108 35,556
Administration expenses........................ 109,268 52,557 43,920
Interest expense............................... 11,523 7,176 --
Amortization of intangible assets.............. 23,926 5,844 --
--------- --------- --------
Total expenses............................... 623,796 477,010 484,833
--------- --------- --------
Income before minority interest and income tax
expense......................................... 593,852 682,016 497,118
Minority interest in net income of subsidiary.. 826 (30) --
Income tax expense............................. 5,363 5,085 2,805
--------- --------- --------
Net income....................................... $ 587,663 $ 676,961 $494,313
========= ========= ========
Weighted average ordinary shares and ordinary
share equivalents outstanding--basic............ 92,975 85,120 90,734
========= ========= ========
Weighted average ordinary shares and ordinary
share equivalents outstanding--diluted.......... 94,785 86,314 91,328
========= ========= ========
Earnings per ordinary share and ordinary share
equivalent--basic............................... $ 6.32 $ 7.95 $ 5.45
========= ========= ========
Earnings per ordinary share and ordinary share
equivalent--diluted............................. $ 6.20 $ 7.84 $ 5.41
========= ========= ========
</TABLE>
See accompanying notes to Consolidated Financial Statements
36
<PAGE>
XL CAPITAL LTD
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND
COMPREHENSIVE INCOME
FOR THE YEARS ENDED NOVEMBER 30, 1998, 1997 AND 1996
(Expressed in thousands of U.S. dollars)
<TABLE>
<CAPTION>
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Ordinary Shares:
Balance-beginning of year................ $ 844 $ 872 $ 473
Issue of shares.......................... 12 3 1
Issue of shares--Mid Ocean acquisition... 303 -- --
Stock dividend........................... -- -- 441
Exercise of stock options................ 3 3 4
Repurchase of treasury shares............ (44) (34) (47)
---------- ---------- ----------
Balance-end of year.................... 1,118 844 872
---------- ---------- ----------
Contributed Surplus:
Balance-beginning of year................ 290,085 282,980 295,209
Issue of shares.......................... 88,959 10,771 7,493
Issue of shares Mid Ocean acquisition.... 2,189,414 -- --
Exercise of stock options................ 9,147 6,277 6,045
Repurchase of treasury shares............ (288,149) (9,943) (25,767)
---------- ---------- ----------
Balance-end of year.................... 2,289,456 290,085 282,980
---------- ---------- ----------
Net Unrealized Appreciation (Depreciation)
on Investments:
Balance-beginning of year................ 188,444 256,430 283,289
Net change in investment portfolio....... (24,194) (82,521) (26,621)
Net change in investment portfolio of
affiliate............................... (4,297) 14,535 (238)
---------- ---------- ----------
Balance-end of year.................... 159,953 188,444 256,430
---------- ---------- ----------
Deferred Compensation:
Balance-beginning of year................ (11,362) (4,169) (1,657)
Issue of restricted shares............... (11,103) (10,387) (3,799)
Amortization............................. 4,361 3,194 1,287
---------- ---------- ----------
Balance-end of year.................... (18,104) (11,362) (4,169)
---------- ---------- ----------
Retained Earnings:
Balance-beginning of year................ 2,011,119 1,579,925 1,428,819
Net income............................... 587,663 676,961 494,313
Cash dividends paid...................... (150,294) (115,372) (86,586)
Repurchase of treasury shares............ (63,031) (130,395) (256,621)
---------- ---------- ----------
Balance-end of year.................... 2,385,457 2,011,119 1,579,925
---------- ---------- ----------
Total shareholders' equity................. $4,817,880 $2,479,130 $2,116,038
========== ========== ==========
Comprehensive Income:
Net income............................... 587,663 676,961 494,313
Change in net unrealized appreciation
(depreciation) of investments........... (28,491) (67,986) (26,859)
---------- ---------- ----------
Comprehensive income................... $ 559,172 $ 608,975 $ 467,454
========== ========== ==========
</TABLE>
See accompanying notes to Consolidated Financial Statements
37
<PAGE>
XL CAPITAL LTD
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED NOVEMBER 30, 1998, 1997 AND 1996
(Expressed in thousands of U.S. dollars)
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- ----------
<S> <C> <C> <C>
Cash flows provided by operating
activities:
Net income before minority interest. $ 588,489 $ 676,961 $ 494,313
----------- ----------- ----------
Adjustments to reconcile net income
before minority interest to net cash
provided by operating activities:
Net realized gains on sales of
investments.......................... (191,795) (335,939) (206,212)
Amortization of (discounts) premium on
fixed maturities..................... (12,953) (2,163) 7,021
Equity in net income of affiliates net
of cash received..................... (23,585) (34,395) (44,329)
Amortization of deferred compensation. 4,361 3,194 1,287
Amortization of intangible assets..... 23,926 5,844 --
Unpaid losses and loss expenses....... 179,075 208,565 178,596
Reinsurance balances receivable....... (144,910) (109,581) (45,442)
Unearned premiums..................... (16,751) (178,584) 140,239
Prepaid reinsurance premiums.......... 2,973 (45,449) (61,029)
Premiums received in advance.......... (21,539) 16,450 19,376
Deferred acquisition costs............ (3,818) 17,292 10,571
Premiums receivable................... 21,375 154,521 (111,054)
Reinsurance premiums payable.......... 761 37,958 30,524
Accrued investment income............. 10,691 10,729 (2,580)
Accounts payable and accrued
liabilities.......................... 15,570 2,839 11,188
----------- ----------- ----------
Total adjustments................... (156,619) (248,719) (71,844)
----------- ----------- ----------
Net cash provided by operating
activities......................... 431,870 428,242 422,469
----------- ----------- ----------
Cash flow used in investing activities:
Proceeds from sale of fixed maturities
and short-term investments........... 13,709,343 10,332,277 4,283,613
Proceeds from redemption of fixed
maturities and short-term
investments.......................... 530,415 108,220 119,706
Proceeds from sale of equity
securities........................... 850,748 1,164,483 591,366
Purchases of fixed maturities and
short-term investments............... (14,313,067) (10,078,481) (5,059,795)
Purchases of equity securities........ (964,214) (999,384) (374,565)
Deferred gains on forward contracts... (12,295) 7,049 418
Investments in affiliates............. (1,126) (43,184) (19,131)
Purchase of GCR Holdings Limited...... -- (660,137) --
Cash acquired in purchase of Mid Ocean
Limited.............................. 137,483 -- --
Other investments..................... 1,836 154 (13,736)
Other assets.......................... (8,537) (24,185) (20,208)
----------- ----------- ----------
Net cash used in investing
activities......................... (69,414) (193,188) (492,332)
----------- ----------- ----------
Cash flows used in financing activities:
Issuance of restricted shares......... 514 387 695
Proceeds from exercise of share
options.............................. 7,538 6,280 6,049
Repurchase of treasury shares......... (351,225) (140,372) (282,435)
Dividends paid........................ (150,294) (115,372) (86,145)
Proceeds from loans................... 655,000 530,000 11,000
Repayment of loans.................... (495,000) (400,000) --
Minority interest..................... 20,066 25,888 --
----------- ----------- ----------
Net cash used in financing
activities......................... (313,401) (93,189) (350,836)
----------- ----------- ----------
Increase (decrease) in cash and cash
equivalents............................ 49,055 141,865 (420,699)
Cash and cash equivalents--beginning of
year................................... 394,599 252,734 673,433
----------- ----------- ----------
Cash and cash equivalents--end of year.. $ 443,654 $ 394,599 $ 252,734
=========== =========== ==========
Taxes paid.............................. $ 9,207 $ 2,622 $ 1,571
=========== =========== ==========
Interest paid........................... $ 11,443 $ 5,824 $ --
=========== =========== ==========
</TABLE>
38
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended November 30, 1998, 1997 and 1996
(Expressed in U.S. dollars)
1. Organization
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"). In the merger, which was completed on
August 7, 1998, 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.
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.
The Company's reinsurance operations are conducted primarily through XL Mid
Ocean Reinsurance Ltd, an insurance company organized under the laws of
Bermuda ("XLMORe"), and its subsidiaries. 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 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. Each of XLRe, MORe and GCRe was organized as an insurance
company under the laws of Bermuda. XLMORe maintains branches in London,
Singapore and a European contact office in Munich.
The Company's operations at Lloyd's are conducted through The Brockbank
Group plc, a company organized under the laws of England, and its subsidiaries
(together, "Brockbank"). Brockbank is a leading Lloyd's managing agency which
manages five Lloyd's syndicates, two of which 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 the underwriting services it
provides to syndicates.
39
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In October 1998, the Company sold its 21% interest in Venton Holdings
Limited, a Bermuda holding company for the Venton managing agency group at
Lloyd's (together, the "Venton Group"). Prior to the sale, subsidiaries of the
Company provided reinsurance coverage to the Venton Group, which writes
principally professional indemnity, directors' and officers' liability and
fiduciary liability insurance coverages.
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 enter. 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 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 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 a 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. Reeve Court has a total capitalization of approximately
$100 million.
In October 1997, the Company and Risk Capital Holdings, Inc., a Delaware
corporation ("RCHI") which holds all of the outstanding shares of Risk Capital
Reinsurance Company, a Nebraska corporation ("RCRe"), organized LARC Holdings,
Ltd., a Bermuda corporation ("LARC") which holds all of the shares of Latin
American Reinsurance Company, Ltd., a Bermuda insurance company ("LARe"). LARe
has approximately $100 million in shareholders' equity and 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. XLMORe owns approximately 75% of the outstanding shares of
LARC. The Company indirectly owns approximately 28% of RCHI.
In March 1997, XLI became a founding shareholder along with RCHI 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 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 foreign currency
protection product offered by XLI.
2. Operations
(a) Insurance
The Company, through its subsidiaries XLI, XLE, XLIA and XLRS, is a leading
insurer and provides third party general liability insurance, directors and
officers liability insurance, professional liability insurance, employment
practices liability insurance and other liability insurance including,
property insurance, and other
40
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
insurance covers, including political risk insurance and financial products.
The liability insurance is written on an excess basis and the loss experience
is characterized as low frequency and high severity. Property is written on a
pro rata as well as an excess basis. Policies written on a pro rata basis can
attach at much lower levels. As a result, loss experience can be higher
frequency and lower severity.
The insurance subsidiaries have a quota share reinsurance policy with
several U.S. reinsurers, of which one is RCRe, covering general liability
risks only. Under the terms of this reinsurance, the Company will cede either
20% or 25% of each risk depending upon the underlying limit written. 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. All the reinsurers are rated, of which the lowest
as rated by S&P is BBB. Effective September 1, 1997, the insurance
subsidiaries entered into an excess of loss casualty catastrophe reinsurance
contract covering all general liability risks. Under the terms of this policy,
the Company is reinsured for $80 million ultimate net loss each occurrence
excess of a per occurrence retention, subject to an annual aggregate retention
of $110 million. The maximum amount recoverable from the reinsurers will be an
annual aggregate of $250 million. For the year ended November 30, 1998, 97.75%
of this reinsurance has been placed with twenty three 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 3.5%
participation on this program.
Employment practices liability coverage is reinsured on a quota share basis
one third of the first $75 million to a U.S. insurer and cedes the remaining
excess layer of $25 million to a Bermuda based insurer. Both reinsurers are
rated, of which the lowest as rated by A.M. Best is A.
The Company cedes 25% of all property risks to a quota share reinsurance
treaty purchased from several property reinsurers. GCR and MORe were both
participants of this program. All property reinsurers are rated, of which the
lowest as rated by S& P is A-.
XL Risk Solutions and CIGNA Risk Solutions are a coordinated initiative
between XLI and CIGNA Property & Casualty ("CIGNA"). The product provides
combined capacity for traditional casualty and property coverages provided by
XLI or CIGNA. 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 traditional stated levels subject to the
underwriting requirements. 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. These percentages vary from 12.5% to 90%,
but do not exceed XLI's normal capacity on individual lines of cover. XLI may
underwrite an account 100% without CIGNA participation.
Sovereign issues subscription policies with XLI and the other insurance
company each assuming 50% of each policy written. The Company reinsures 10% of
all risks assumed through Sovereign to RCRe.
XLI also offers insurance and reinsurance solutions for complex financial
risks. These include financial insurance and reinsurance, credit enhancement,
swaps and other collateralized transactions for up to $100 million in limits.
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 no formal reinsurance
coverage for these risks, but may cede a portion of some policies to third
parties from time to time.
41
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(b) Reinsurance
The Company, through 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. XLMORe maintains branch offices in London and Singapore as
well as a European contact office in Munich, Germany. The London branch
underwrites marine and energy and aviation risks on a worldwide basis. The
Singapore branch underwrites general reinsurance, treaty and facultative
business.
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.
In August 1998, XLMORe 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 probability 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 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.
LARe 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.
(c) Lloyd's
The Company's wholly owned subsidiary, Brockbank, is a leading Lloyd's
managing agency which manages five syndicates, two of which are dedicated
corporate syndicates whose capital is solely provided by the Company. These
corporate syndicates write property, marine and energy, aviation and
satellite, motor, professional indemnity and other specialty lines, primarily
of insurance but also reinsurance.
3. 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
accounting principles generally accepted in the United States of America. All
material intercompany accounts and transactions have been eliminated. The
preparation of financial statements in conformity with generally accepted
accounting principles 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.
The comparative consolidated financial statements are those of EXEL, the
Company's predecessor, as previously discussed in note 1.
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.
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
42
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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 under the multi-year alternate rating methodology may be
subject to a mandatory reinstatement premium in the event of a loss. An asset
is accrued to reflect the obligation of the insured's reinstatement premium
and the premium is earned in accordance with the "with or without" method;
that is, the pricing of the premium is evaluated in terms of a no loss
situation and the resultant premium is earned over the remaining term of the
policy. The balance of the reinstatement premium is earned to the extent of
the loss reaching the full policy limit; that is, in the event of a full limit
loss the balance of the reinstatement premium together with any unearned
premium of the underlying cover would be fully earned. 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 and other costs related to those premiums
are also considered in determining the level of acquisition costs to be
deferred.
(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. For those
reinsurance policies that provide coverage to the Company over the term of the
underlying business, the premiums ceded and commissions recorded thereon are
expensed and earned on a monthly pro-rata basis over the estimated term of
those policies. Amounts recoverable from reinsurers are estimated in a manner
consistent with the claim liability associated with the reinsured policy.
(d) Investments
Investments are 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 as a separate
component of shareholders' equity.
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 marked to market, 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
The functional and reporting currency of the Company and its subsidiaries is
U.S. dollars. Monetary assets and liabilities denominated in foreign
currencies are translated at the exchange rate in effect at the balance sheet
43
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
date with the resulting foreign exchange gains and losses recognized in
income, unless the foreign currency exposure is directly hedged as discussed
in note 3 (d). Revenue and expense transactions are translated at the average
exchange rates prevailing during the year.
(f) Investments in Affiliates
The Company accounts for its investments in affiliates on the equity basis.
(g) Other Investments
The Company accounts for its other investments on a cost basis as it has no
significant influence over these entities. Assets are written down to their
realizable value where 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
determine that an impairment exists, the excess of the unamortized balance
over the fair value of the intangible asset will be charged to earnings.
(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.
The Company recognizes as a component of loss reserves, the loss experience
accounts of insurers for policies written under the applicable multi-year
alternate rating methodology. Such 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 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 claims that may penetrate the minimum attachment
point. However, there can be no assurance that losses will not exceed the
Company's total reserves. The methodology of estimating the reserve 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) 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.
44
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(k) Earnings per Ordinary Share and Ordinary Share Equivalent
The Company has adopted Statement of Financial Accounting Standards ("SAFS")
No. 128, "Earnings per Share". SFAS No. 128 replaced primary and fully diluted
earnings per share with basic and diluted earnings per share. Basic earnings
per share is calculated by dividing net income by the weighted average number
of ordinary shares outstanding for each period. Diluted earnings per share
reflects the potential dilution that could occur if the securities to issue
ordinary shares were exercised into ordinary shares. Prior years earnings per
share amounts have been restated to reflect this.
4. Investments
Net investment income is derived from the following sources (U.S. dollars in
thousands):
<TABLE>
<CAPTION>
Year ended November 30,
--------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Fixed maturities, short-term investments and cash
and cash equivalents............................... $285,797 $220,859 $200,711
Equity securities................................... 13,248 14,516 11,752
-------- -------- --------
Total investment income........................... 299,045 235,375 212,463
Investment expenses............................... 19,670 18,823 13,865
-------- -------- --------
Net investment income............................. $279,375 $216,552 $198,598
======== ======== ========
</TABLE>
The following represents an analysis of realized and the change in
unrealized appreciation (depreciation) on investments (U.S. dollars in
thousands):
<TABLE>
<CAPTION>
Year ended November 30,
-------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Net realized gains (losses):
Fixed maturities and short-term investments:
Gross realized gains........................ $ 420,918 $ 177,331 $ 103,830
Gross realized losses....................... (379,974) (168,048) (53,463)
--------- --------- ---------
Net realized gains........................ 40,944 9,283 50,367
Equity securities:
Gross realized gains........................ 605,525 370,949 288,272
Gross realized losses....................... (468,811) (44,293) (132,427)
--------- --------- ---------
Net realized gains........................ 136,714 326,656 155,845
Net realized gain on sale of investment in
affiliate.................................. 14,137 -- --
--------- --------- ---------
Net realized gains on investments......... 191,795 335,939 206,212
--------- --------- ---------
Change in unrealized appreciation
(depreciation):
Fixed maturities and short-term investments. (38,762) 19,391 (58,654)
Equity securities........................... 24,127 (108,961) 31,616
Deferred gains on forward contracts......... (12,295) 7,049 418
Investment portfolio of affiliates.......... (1,561) 14,535 (239)
--------- --------- ---------
Net change in unrealized appreciation
(depreciation) on investments................ (28,491) (67,986) (26,859)
--------- --------- ---------
Total net realized and change in
unrealized appreciation (depreciation) on
investments.............................. $ 163,304 $ 267,953 $ 179,353
========= ========= =========
</TABLE>
45
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The cost (amortized cost for fixed maturities and short-term investments),
market value and related unrealized gains (losses) of investments are as
follows (U.S. dollars in thousands):
<TABLE>
<CAPTION>
Cost or Gross Gross
Amortized Unrealized Unrealized Market
November 30, 1998 Cost Gains Losses Value
- ----------------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Fixed maturities:
U.S. Government and Government
agency.......................... $1,564,084 $ 18,592 $ (1,823) $1,580,853
Corporate bonds.................. 3,231,757 65,620 (68,023) 3,229,354
Non-U.S. Sovereign Government
bonds........................... 401,405 16,721 (15,752) 402,374
---------- -------- -------- ----------
Total fixed maturities......... $5,197,246 $100,933 $(85,598) $5,212,581
========== ======== ======== ==========
Short-term investments:
U.S. Government and Government
agency.......................... $ 38,187 $ 224 $ -- $ 38,411
Corporate bonds.................. 66,329 62 (313) 66,078
Non-U.S. Sovereign Government
bonds........................... 16,661 255 (191) 16,725
---------- -------- -------- ----------
Total short-term investments... $ 121,177 $ 541 $ (504) $ 121,214
========== ======== ======== ==========
Total equity securities............ $ 995,873 $208,390 $(75,662) $1,128,601
========== ======== ======== ==========
<CAPTION>
November 30, 1997
- -----------------
<S> <C> <C> <C> <C>
Fixed maturities:
U.S. Government and Government
agency.......................... $1,055,581 $ 7,318 $ (612) $1,062,287
Corporate bonds.................. 1,545,473 52,504 (8,095) 1,589,882
Non-U.S. Sovereign Government
bonds........................... 543,588 12,112 (10,997) 544,703
---------- -------- -------- ----------
Total fixed maturities......... $3,144,642 $ 71,934 $(19,704) $3,196,872
========== ======== ======== ==========
Short-term investments:
U.S. Government and Government
agency.......................... $ 9,941 $ 4 $ -- $ 9,945
Corporate bonds.................. 197,770 209 (56) 197,923
Non-U.S. Sovereign Government
bonds........................... 12,427 -- (326) 12,101
---------- -------- -------- ----------
Total short-term investments... $ 220,138 $ 213 $ (382) $ 219,969
========== ======== ======== ==========
Total equity securities........ $ 729,888 $154,177 $(46,238) $ 837,827
========== ======== ======== ==========
</TABLE>
The contractual maturities of fixed maturity securities as of November 30,
1998 and 1997 are shown below (U.S. dollars in thousands). 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>
November 30, 1998 November 30, 1997
--------------------- ---------------------
Amortized Market Amortized Market
Cost Value Cost Value
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Due after 1 through 5 years......... $2,006,607 $2,005,998 $ 966,598 $ 967,571
Due after 5 through 10 years........ 1,104,581 1,111,435 785,625 799,996
Due after 10 through 15 years....... 331,643 344,149 237,296 236,691
Due after 15 years.................. 948,102 936,709 776,202 808,729
Mortgage-backed investments......... 806,313 814,290 378,921 383,885
---------- ---------- ---------- ----------
$5,197,246 $5,212,581 $3,144,642 $3,196,872
========== ========== ========== ==========
</TABLE>
46
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
5. Investment in Affiliates
The Company owned 27.9% of the issued shares of RCHI as at November 30, 1998
and 1997, respectively. Outstanding share warrants if exercised would dilute
the Company's ownership to 22.1% as at November 30, 1998. RCHI commenced
operations on November 6, 1995.
The Company owns 28% 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 November 30, 1998, no contracts were written.
The Company owned 29.1% of the issued voting shares and 24.8% of the total
issued shares of Mid Ocean as at November 30, 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 (as previously
discussed in note1) and has been consolidated as a wholly owned subsidiary of
XL.
In June 1997, XL acquired 21% of Venton from the Trident Partnership L.P.,
of which XL is a 10.7% limited partner. Venton 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 Venton
to an unrelated third party for $ 41.4 million cash, realizing a net gain of
$14.1 million.
6. Intangible Assets
Intangible assets comprises of goodwill arising primarily from the purchase
of Mid Ocean. The purchase price amounted to $ 2.2 billion of which $900
million represented the fair value of its net assets not already owned by the
Company with the balance of $1.3 billion representing goodwill which is being
amortized over 40 years. The balance of the goodwill mostly relates to the GCR
acquisition. This component of goodwill is being amortized over 20 years.
7. Losses and Loss Expenses
Unpaid losses and loss expenses comprise (U.S. dollars in thousands):
<TABLE>
<CAPTION>
Year ended November 30,
----------------------------------
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Reserve for reported losses and loss
expenses.................................. $1,368,129 $ 862,999 $ 803,893
Reserve for losses incurred but not
reported.................................. 1,753,610 1,479,255 1,295,203
---------- ---------- ----------
Unpaid losses and loss expenses............ $3,121,739 $2,342,254 $2,099,096
========== ========== ==========
Losses and loss expenses incurred comprise (U.S. dollars in thousands):
Loss and loss expense payments............. $ 366,475 $ 267,226 $ 302,642
Change in unpaid losses and loss expenses.. 182,426 206,220 158,670
Reinsurance recoveries..................... (158,418) (108,121) (55,955)
---------- ---------- ----------
Losses and loss expenses incurred.......... $ 390,483 $ 365,325 $ 405,357
========== ========== ==========
</TABLE>
47
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Reconciliation of unpaid losses and loss expenses (U.S. dollars in
thousands):
<TABLE>
<CAPTION>
Year ended November 30,
----------------------------------
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Unpaid losses and loss expenses at beginning
of period.................................. $2,342,254 $2,099,096 $1,920,500
Losses and loss expenses incurred in respect
of losses occurring in:
Current year.............................. 713,059 735,313 436,334
Prior years............................... (164,158) (260,407) 14,465
---------- ---------- ----------
Total (Net of reinsurance 1998:
$390,483--1997: $365,325--1996:
$405,357............................... 548,901 474,906 450,799
---------- ---------- ----------
Interest incurred on experience reserves.. 1,798 886 1,752
Loss reserves acquired.................... 595,261 34,593 28,687
Losses and loss expenses paid in respect of
losses
occurring in:
Current Year.............................. 167,409 34,055 3,177
Prior years............................... 199,066 233,172 299,465
---------- ---------- ----------
Total....................................... 366,475 267,227 302,642
---------- ---------- ----------
Unpaid losses and loss expenses at end of
period..................................... $3,121,739 $2,342,254 $2,099,096
========== ========== ==========
</TABLE>
The 1998 current year losses reflects the inclusion of the operations of Mid
Ocean acquired on August 7, 1998. The results include four months of XLMORe
and three months of Brockbank. These operations incurred $169 million in gross
losses for the reported period. These losses were largely attributable to
Hurricane Georges and the SwissAir airline disaster. In addition, losses for
Brockbank attach at the primary layers and therefore are more frequent in
nature. These losses are also significantly reinsured.
Prior year incurred losses in 1998 were effected in part, by the release of
insurance reserves established for the Company's professional lines. These
reserves were reduced in accordance with actuarial estimates. In addition,
reserves were released on specialty cover policies for the years 1995 through
1997 due to the absence of losses that would affect the Company's layers.
These policies were for a three-year period, written on a claims-made basis
and expired in 1998.
The high level of the 1997 current year incurred losses was due to the fact
that three new 1997 casualty indemnity reserves totaling $145 million were
established. Historically, such losses have not emerged this quickly. Should
actual loss activity prove to be different, these reserves will be adjusted
accordingly.
The 1997 losses were offset by the release of $260 million in reserves that
related to prior years in accordance with actuarial estimates.
8. Commitments and Contingencies
(a) Letters of Credit
In February 1998, subsidiaries of the Company established a $500 million
letter of credit facility with a syndicate of commercial banks led by Mellon
Bank N.A. Letters of credit issued under this facility are collateralized by
pledged securities in XLI's fixed maturity investment portfolio. Letters of
credit totalling approximately $80.6 million and $155.8 million were
outstanding as at November 30, 1998 and 1997, respectively.
Mid Ocean had a $325 million letter of credit facility with Citibank N.A.,
London Branch. Letters of credit issued under this facility are collateralized
by pledged securities in Mid Ocean's investment portfolio. This
48
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
facility remains in place following the merger with Mid Ocean. Letters of
credit totaling approximately $223.0 million were outstanding as at November
30, 1998. This amount includes $169.5 million in respect of the Lloyd's
corporate syndicates which has been issued in lieu of paid in capital.
(b) 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 non-U.S.
dollar fixed maturities and its non-U.S. dollar equity investments on an
overlay basis. The fair value of the Company's non-U.S. dollar denominated
investments as at November 30, 1998 and 1997 was $535.3 million and $566.1
million, respectively. 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 November 30, 1998, forward foreign exchange contracts with
notional principal amounts totalling $322.3 million were outstanding. The
fair value of these contracts as at November 30, 1998, was $308.4 million
with unrealized losses of $13.9 million. Gains of $3.8 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 non-U.S.
dollar 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 November 30, 1998,
the Company had a $2.4 million of such contracts outstanding, and had
recognized a total of $0.4 million in realized and unrealized losses for
the year.
The Company attempts to hedge directly the foreign currency exposure of a
portion of its non-U.S. dollar 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 November 30, 1998, the Company had, as hedges,
foreign contracts for the sale of $17.5. million and the purchase of $0.1
million of foreign currencies at fixed rates, primarily New Zealand dollars
(73% of net contract value), Danish Kroner (14%) and Swedish Kroner (13%).
The market value of non-U.S. dollar fixed maturities held by the Company as
at November 30, 1998 was $19.0 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 November 30, 1998, unrealized
deferred gains amounted to $0.1 million, and were offset by corresponding
decreases 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
November 30, 1998, realized deferred losses amounted to $2.0 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 the notional principal
amounts and the associated market value is the Company's maximum credit
exposure.
49
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(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 November 30, 1998, the
portfolio held $138.3 million in exposure to S&P 500 Index futures together
with fixed maturities, short-term investments and cash amounting to $ 139.5
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 November 30, 1998,
net realized gains from index futures totaled $25.8 million.
Derivative investments are also utilized to add value to the portfolio
where market inefficiencies are believed to exist. At November 30, 1998,
bond and stock index futures outstanding were $333.4 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.
(c) 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 November 30, 1998.
(d) 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 November 30, 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
November 30, 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.
(e) Properties
The Company rents space for its principal executive offices under leases
which expire up to June, 2009. Total rent expense for the years ended November
30, 1998, 1997 and 1996 were approximately $3.7 million, $2.1 million and $1.8
million, respectively. Future minimum rental commitments under existing leases
are expected to be approximately $4.0 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 $110.0 million, of which $23.7 million has been
spent to date. It is estimated that the development will be completed sometime
in 2001. Upon completion of the headquarters project, it is expected that the
Company's rental commitments will be reduced.
9. Credit Agreements
In 1997, subsidiaries of the Company obtained two unsecured revolving lines
of credit of $250 million each, one for 364 days (short-term) and the other
for 5 years (long-term), from a syndicate of nine major international banks
led by Mellon Bank, N.A. During the year, a total of $505.0 million was
borrowed at a weighted average rate of 5.667%. Total interest expense and
facility costs amounted to $9.5 million and $7.18 million for the years ended
November 30, 1998 and 1997, respectively. As at November 30, 1998, the
outstanding balance was $190.0 million drawn under the long-term facility and
is repayable within the next twelve months.
50
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
On June 27, 1996, the Company borrowed $11.0 million from the Bank of
Bermuda (New York) Limited in order to fund its investment in Pareto Partners,
Inc., an investment management company. The loan is repayable in four years.
During the year the weighted average interest rate charged on the loan was
6.02%. Total interest expense amounted to $0.7 million and $0.7 million for
the years ended November 30, 1998 and 1997 respectively.
Mid Ocean had obtained multi-currency committed lines of credit provided by
a syndicate of nine major international banks led by Chase Manhattan Bank,
N.A. which provides for unsecured borrowing up to an aggregate amount of $200
million subject to certain conditions. The Mid Ocean facility is split evenly
between a 364-day and a 5-year facility. These facilities remained in place
following the merger with Mid Ocean. In August 1998, $50 million was borrowed
from this facility and lent to XL in connection with the merger with Mid
Ocean. This was repaid in November 1998. During this period the weighted
average interest rate charged on the loan was 5.760% and the total interest
expense amounted to $0.7 million.
In 1998, XLA obtained an unsecured revolving line of credit of $100 million
for 364 days from Mellon Bank, N.A. During the year the full amount of this
facility was borrowed at a weighted average rate of 5.898%. Total interest
expense and facility costs amounted to $1.3 million for the year ended
November 30, 1998. As at November 30, 1998, the outstanding balance was $100.0
million and is repayable within the next twelve months. This line of credit
was replaced in December 1998 with a $150 million commercial paper funding
facility provided by the same bank. XLI guarantees the indebtedness of XLA
under this facility.
The credit agreements for all facilities contains various financial and non-
financial covenants. The Company and its subsidiaries were in compliance with
all covenants as at November 30, 1998.
10. Share Capital
(a) Authorized and Issued
The authorized share capital is 999,990,000 ordinary shares, par value $0.01
per share, divided into Class A and Class B ordinary shares. 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 (in
thousands):
<TABLE>
<CAPTION>
Year ended November 30,
-----------------------------
1998 1997 1996
--------- -------- --------
<S> <C> <C> <C>
Balance--beginning of year....................... 84,407.6 87,170.6 94,550.8
Exercise of options.............................. 307.2 342.5 600.9
Issuance of restricted shares.................... 140.2 284.2 224.0
Repurchase of shares............................. (3,243.2) (3,389.7) (8,205.1)
Issuance of Class A shares....................... 27,076.3 -- --
Issuance of Class B shares....................... 3,115.9 -- --
--------- -------- --------
Balance--end of year............................. 111,804.0 84,407.6 87,170.6
========= ======== ========
</TABLE>
The issuances of Class A shares were in exchange for Mid Ocean shares (26.0
million shares) and FSA shares (1.1 million shares). The issuance of Class B
shares was in exchange for the Mid Ocean Class B and Class C shares.
(b) Share Repurchases
The Board of Directors has authorized the repurchase of the Company's
ordinary shares through several buy back programs. During 1998 the Company
repurchased 3.2 million shares at an aggregate cost of $255.2
51
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
million. On March 13, 1998, the Board of Directors discontinued its existing
share repurchase program and authorized a program for $500 million of the
Company's ordinary shares. In August 1998, $300 million of share repurchases
related to the merger with Mid Ocean. In addition, the Company had purchased a
further 732,000 shares at a cost of $51.2 million during the year.
(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 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 over the five-year restriction
period. Restricted stock issued under the plan totaled 131,936 shares, 274,300
shares and 120,500 shares in 1998, 1997 and 1996, respectively.
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.
Under this plan, 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 share units
calculated by dividing 110% of the deferred payment by the market value of the
Company's stock at the beginning of the fiscal year. Directors also may elect
to receive their annual retainer in the form of shares with a value equal to
the amount of their annual fee. 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.
(d) SFAS 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
the stock option
52
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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 (U.S. dollars
in thousands, except per share amounts):
<TABLE>
<CAPTION>
Year Ended November 30,
1998
--------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Net income--as reported............................. $587,663 $676,961 $494,313
Net income--proforma................................ $569,516 $672,145 $492,722
Basic earnings per share--as reported............... $ 6.32 $ 7.95 $ 5.45
Basic earnings per share--proforma.................. $ 6.13 $ 7.90 $ 5.43
Diluted earnings per share--as reported............. $ 6.20 $ 7.84 $ 5.41
Diluted earnings per share--proforma................ $ 6.01 $ 7.78 $ 5.40
</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.................................... 2.35% 2.64% 2.66%
Risk free interest rate........................... 5.32% 5.37% 5.96%
Expected volatility............................... 23.57% 18.49% 19.28%
Expected lives.................................... 10 years 10 years 10 years
</TABLE>
The fair value of options granted was $40.7 million, $9.9 million and $4.3
million for the years ended November 30, 1998, 1997 and 1996, respectively.
Total stock based compensation recognized in net income was $4.4 million in
1998, $3.2 million in 1997 and $1.3 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................ 2,772,697 $28.04 2,112,148 $21.69 2,228,582 $16.37
Granted................. 1,090,700 $66.53 1,006,990 $37.53 487,400 $31.60
Granted--Mid Ocean
conversion............. 791,573 $72.44 -- -- -- --
Exercised............... (307,215) $29.78 (346,241) $18.07 (600,938) $ 9.21
Canceled................ (4,666) $36.92 (200) $18.75 (2,896) $19.39
--------- --------- ---------
Outstanding--end of
year................... 4,343,089 $45.67 2,772,697 $28.04 2,112,148 $21.69
Options exercisable..... 2,461,042 1,335,798 1,180,482
========= ========= =========
Options available for
grant.................. 2,707,180* 3,943,380* 2,775,670*
========= ========= =========
</TABLE>
- --------
*Available for grant includes shares which may be granted on either stock
options or restricted stock.
(f) Voting
The Company's Articles of Association restrict the voting power of any
person to less than 10% of total voting power.
53
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(g) Share Rights Plan
Rights to purchase Class A Ordinary Shares were distributed as a dividend at
the rate of one Right for each outstanding Class A Ordinary Share held of
record as of the close of business on October 31, 1998. Each Right will
entitle holders of XL Class A Ordinary Shares to buy one ordinary share at an
exercise price of $350.00. The Rights would be exercisable, and would detach
from the Class A Ordinary Shares, only if a person or group were to acquire 20
percent or more of XL's outstanding Class A Ordinary Shares, or were to
announce a tender or exchange offer that, if consumated, would result in a
person or group beneficially owning 20 percent or more of XL's Class A
Ordinary Shares. Upon a person or group without prior approval of the Board
acquiring 20 percent 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 the Rights.
11. 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.
12. Premiums
Premiums comprise (U.S. dollars in thousands):
<TABLE>
<CAPTION>
Year ended November 30,
-------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Gross premiums written--
direct..................... $ 505,263 $ 418,372 $ 584,585
Gross premiums written--
assumed.................... 301,598 22,918 144,861
Reinsurance premiums ceded.. (134,817) (124,664) (132,344)
--------- --------- ---------
Net premiums written.... 672,044 316,626 597,102
Change in unearned and
prepaid premiums........... 13,156 224,027 (79,210)
--------- --------- ---------
Net premiums earned..... $ 685,200 $ 540,653 $ 517,892
========= ========= =========
</TABLE>
13. Reinsurance
The Company is liable with respect to reinsurance ceded to the extent that
any reinsurance company fails to meet its obligation to the Company. The
Company regularly monitors the financial condition of its reinsurers and
believes there to be no material unrecoverable reinsurance.
14. Dividends
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.
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.
54
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
15. Taxation
Under current Cayman Islands law, XL will not be obliged to pay any taxes in
the Cayman Islands on its income or gains until May 2006 pursuant to the
provisions of the Tax Concessions Law, as amended.
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.
X.L. 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 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 Company has no material deferred taxes.
16. 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 XLMORe. The payment of such
dividends is restricted by applicable law including Bermuda, the United
States, the Republic of Ireland and United Kingdom insurance law and
regulations, and 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. Other
subsidiaries of the Company based in Bermuda, including XLFA, LARe and Reeve
Court, are also subject to regulation under the Act.
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
(U.S. dollars in thousands):
<TABLE>
<CAPTION>
Year ended November 30,
---------------------------------------------------------
XLI 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>
55
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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 margins. 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 insurances. 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 (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 (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 (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, Trade and Employment.
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. 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
special 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. 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, among 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 assurance, however, that the activities of the Company will
not be challenged in the 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.
56
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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, "effects and carries
on" business in the United Kingdom and is therefore regulated by the UK FSA.
Lloyd's
As a result of the Company's ownership of Brockbank, the Company and
Brockbank 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 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 a 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% or 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 and Germany as
a result of its representative offices and branches in such jurisdictions.
57
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
17. Unaudited Quarterly Financial Data
The unaudited quarterly financial data for 1998 and 1997 follows (U.S.
dollars in thousands, except per share amounts):
<TABLE>
<CAPTION>
First Second Third Fourth
Quarter Quarter Quarter Quarter
-------- -------- -------- --------
<S> <C> <C> <C> <C>
1998
Net premiums earned.................... $139,882 $137,787 $155,514 $252,017
Net investment income.................. 57,528 60,452 70,983 90,412
Realized gains (losses)................ 62,951 74,541 (2,837) 57,140
Equity in net income (loss) of
affiliates............................ 15,207 19,728 14,604 (1,559)
Fee and other income................... -- 4,145 2,132 7,021
-------- -------- -------- --------
Total revenues......................... $275,568 $296,653 $240,396 $405,031
======== ======== ======== ========
Income before income tax expense....... $157,191 $171,832 $ 86,621 $178,208
======== ======== ======== ========
Net income............................. $155,410 $170,562 $ 85,830 $175,861
======== ======== ======== ========
Net income per share and share
equivalent--basic..................... $ 1.84 $ 2.02 $ 0.94 $ 1.58
======== ======== ======== ========
Net income per share and share
equivalent--diluted................... $ 1.81 $ 1.98 $ 0.91 $ 1.56
======== ======== ======== ========
1997
Net premiums earned.................... $119,837 $129,817 $138,034 $152,965
Net investment income.................. 51,557 54,160 56,109 54,726
Realized gains (losses)................ 32,613 126,313 116,400 60,613
Equity in net income of affiliates..... 13,155 15,739 16,219 20,769
-------- -------- -------- --------
Total revenues......................... $217,162 $326,029 $326,762 $289,073
======== ======== ======== ========
Income before income tax expense....... $110,711 $211,580 $207,438 $152,055
======== ======== ======== ========
Net income............................. $108,118 $211,580 $206,560 $150,703
======== ======== ======== ========
Net income per share and share
equivalent--basic..................... $ 1.24 $ 2.49 $ 2.45 $ 1.79
======== ======== ======== ========
Net income per share and share
equivalent--diluted................... $ 1.23 $ 2.46 $ 2.41 $ 1.75
======== ======== ======== ========
</TABLE>
18. Accounting Standards
The Financial Accounting Standards Board ("FASB") issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information",
effective for fiscal years beginning after December 15, 1997. This statement
established standards for reporting information about operating segments in
annual financial statements and requires selected information about operating
segments in interim financial reports issued to shareholders. It also
established standards for related disclosures about products and services,
geographical areas and major customers. Under SFAS No. 131, operating segments
are to be determined consistent with the way that management organizes and
evaluates financial information internally for making operating decisions and
assessing performance. The Company has not yet assessed the affect of the
adoption of this accounting standard on its consolidated financial statement
disclosures.
FASB issued SFAS No. 132, "Employers' Disclosures about Pensions and Other
Postretirement Benefits", effective for fiscal years beginning after December
15, 1997. This Statement revises employers' disclosures about pensions and
other postretirement benefit plans. This standard is expected to have a
minimal impact on the Company's consolidated financial disclosures.
58
<PAGE>
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Concluded)
FASB also issued SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities", effective for all fiscal quarters of fiscal years
beginning after June 15, 1999. This Statement establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts (collectively referred to as
derivatives), and for hedging activities. It requires that an entity recognize
all derivatives as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. If certain conditions
are met, a derivative may be specifically designated as a hedge. The
accounting for changes in fair value of a derivative (that is, gains and
losses) depends on the intended use of the derivative and the resulting
designation. The Company has not yet assessed the affect of the adoption of
this accounting standard on its consolidated financial statement disclosures.
SFAS No. 131 and No. 133 are not expected to have a significant impact on
the Company's overall results but will affect the Company's financial
statements and disclosures.
19. Unaudited Subsequent Events
On December 2, 1998, the Company announced that it has signed a definitive
agreement to acquire all of the outstanding shares of Intercargo Corporation
("Intercargo") for $12 per share, or approximately $88 million. Intercargo,
through its subsidiaries, underwrites specialty insurance products for
companies engaged in international trade, including U.S. customs bonds and
marine cargo insurance. At September 30, 1998, Intercargo had total assets of
$165 million and shareholders' equity of $81 million. The transaction is
subject to approval by Intercargo's shareholders, regulatory approvals and
other customary closing conditions. There can be no assurance that the
transaction will be completed or that the terms of the transaction will not be
modified prior to completion.
On February 16, 1999 the Company announced that it had signed a definitive
merger agreement with NAC Re Corporation ("NAC Re"). Under the terms of the
agreement, shareholders of NAC Re will receive 0.915 Class A XL shares for
each NAC Re share in a tax-free exchange of shares that will be accounted for
as a pooling of interests under U.S. generally accepted accounting principles
("GAAP"). The transaction is subject to the approval of the NAC Re
stockholders, expiration of the applicable waiting period under the Hart-
Scott-Rodino Antitrust Improvements Act, receipt of insurance, regulatory
approvals and other customary closing conditions. There can be no assurance
that the transaction will be completed or that the terms of the transaction
will not be modified prior to completion.
59
<PAGE>
XL CAPITAL LTD
PRO FORMA FINANCIAL INFORMATION
On March 16, 1998, the combination of EXEL and Mid Ocean was announced. The
shareholders of the two companies approved the two schemes of arrangement on
August 3, 1998 and the Grand Court of Cayman approved the arrangements on
August 7, 1998. The Company is the holding company for the new organization,
and the reinsurance operations of both companies were combined on August 7,
1998. The transaction, detailed in the joint proxy statement filed with the
Securities and Exchange Commission on July 2, 1998, resulted in XL issuing
1.0215 shares for each Mid Ocean share (other than Mid Ocean shares held by
EXEL and its subsidiaries), subject to the cash election rights of the two
companies' shareholders described therein. Prior to this transaction, EXEL
owned approximately 25% of Mid Ocean Class A shares.
As a result of the combination, the Company assumed assets of $2.6 billion,
of which invested assets were $1.8 billion, and liabilities if $1.2 billion,
including loss reserves of $595 million.
PRO FORMA CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(U.S. dollars in thousands, except per share amounts)
<TABLE>
<CAPTION>
Pro Forma Pro Forma
1998 1997
---------- ----------
<S> <C> <C>
Net premiums earned...................................... $1,055,935 $1,033,121
Net investment income.................................... 362,930 319,981
Net realized gains....................................... 225,534 335,538
Equity in affiliate income............................... (1,897) 3,748
Fee and other income..................................... 28,006 24,710
---------- ----------
Total revenues....................................... 1,670,508 1,717,098
---------- ----------
Losses and loss expenses................................. 569,130 587,414
Acquisition costs and administration expenses............ 307,448 234,949
Interest expense......................................... 23,123 24,576
Amortization of intangible assets........................ 45,000 37,192
---------- ----------
Total expenses....................................... 944,701 884,131
---------- ----------
Income before minority interest and income tax expense... 725,807 832,967
Minority interest and income tax......................... 12,703 18,500
---------- ----------
Net income........................................... $ 713,104 $ 814,467
---------- ----------
Net income per share
Basic.................................................. $ 6.42 $ 7.29
Diluted................................................ $ 6.31 $ 7.20
Weighted average shares outstanding (000's)
Basic.................................................. 111,155 111,734
Diluted................................................ 112,964 113,133
</TABLE>
This unaudited condensed pro forma financial information should be read in
conjunction with the following explanatory notes.
60
<PAGE>
XL CAPITAL LTD
NOTES TO THE UNAUDITED PROFORMA COMBINED CONDENSED
FINANCIAL INFORMATION
1. Accounting for the Arrangements
(a) The combination of EXEL and Mid Ocean was accounted for under purchase
accounting rules, in accordance with generally accepted accounting practice,
whereby the total purchase cost is allocated to the assets and liabilities
acquired based on their relative values at the date of acquisition, and the
excess of that total purchase cost over the fair values is recorded as
goodwill. The fair values ascribed to the individual assets and liabilities
are based upon management studies and appraisals.
(b) Included in the pro forma income statements for the year ended November
30, 1998 and 1997 is the financial information of Mid Ocean for the nine
months ended July 31, 1998 and the year ended October 31, 1997, respectively.
No adjustments have been made to take account of these differing period ends
as, in the opinion of management, any such adjustments would not be material.
2. Allocation of Purchase Price Consideration:
The allocation of the purchase price is as follows (U.S. dollars in
thousands):
<TABLE>
<S> <C>
Fair value of assets of Mid Ocean at date of acquisition............. 1,360,760
Equity value of Mid Ocean assets already held........................ (377,214)
---------
Fair value of share of net assets acquired by EXEL................... 983,546
Goodwill relating to acquisition..................................... 1,253,920
---------
2,237,466
---------
The consideration for the arrangements was as follows:
Issue of New EXEL shares............................................. 2,109,804
Issue of New EXEL options............................................ 26,800
Mid Ocean shares purchased for cash.................................. 85,607
Cost of acquisition.................................................. 15,255
---------
2,237,466
---------
</TABLE>
61
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Shareholders of XL Capital Ltd:
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income, of shareholders' equity and comprehensive
income and of cash flows present fairly, in all material respects, the
financial position of XL Capital Ltd and its subsidiaries at November 30, 1998
and 1997, and the results of their operations and their cash flows for each of
the three years in the period ended November 30, 1998, in conformity with
accounting principles generally accepted in the United States of America.
These financial statements are the responsibility of the company's management;
our responsibility is to express an opinion on these financial statements
based on our audits. We conducted our audits of these statements in accordance
with auditing standards generally accepted in the United States of America
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.
PricewaterhouseCoopers LLP
New York, New York
December 23, 1998
62
<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
November 30, 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 will be 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 herein by reference.
Item 11. Executive Compensation
This item is omitted because a definitive proxy statement which involves the
election of directors will be 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 herein 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 will be 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 herein by reference.
Item 13. Certain Relationships and Related Transactions
This item is omitted because a definitive proxy statement which involves the
election of directors will be 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 herein by reference.
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) Financial Statements and Exhibits.
1. Financial Statements
Included in Part II--See Item 8 of this report.
2. Financial Statement Schedules
Included in Part IV of this report:
<TABLE>
<CAPTION>
Schedule
Number Page
-------- ----
<S> <C> <C>
--Auditor's Report on Financial Statement Schedules
included in Form 10-K..................................... 66
--Consolidated Summary of Investments--Other than
Investments in Related Parties, as of November 30, 1998... I 67
--Condensed Financial Information of Registrant, as of
November 30, 1998 and 1997, and for the years ended
November 30, 1998, 1997 and 1996.......................... II 68
--Reinsurance, for the years ended November 30, 1998, 1997
and 1996.................................................. IV 71
--Supplementary Information Concerning Property/Casualty
Insurance Operations for the years ended November 30,
1998, 1997 and 1996....................................... VI 72
</TABLE>
63
<PAGE>
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, 1998 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.
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
10.9.2 Amendment to Mid Ocean Limited 1993 Long Term Incentive and Share
Award Plan
10.10 Mid Ocean Ltd. Stock & Deferred Compensation Plan for Nonemployee
Directors
10.11.1 Mark E. Brockbank Employment Agreement
10.11.2 Henry C.V. Keeling Employment Agreement
10.11.4 Robert J. Newhouse, Jr. Employment Agreement
10.11.5 Michael A. Butt Employment Agreement
10.12.1 Amendment to Brockbank Service Agreement
10.12.2 Amendment to Keeling Service Agreement
10.12.3 Amendment to Newhouse Service Agreement
10.12.4 Amendment to Butt Service Agreement
10.13 Robert J. Newhouse Consulting Agreement
10.14.1 Credit Agreement (5-Year) between Mid Ocean Limited and The Chase
Manhattan Bank
10.14.2 Amendment No. 1 to Credit Agreement (5-Year) between Mid Ocean
Limited and The Chase Manhattan Bank
10.14.3 Credit Agreement (364-Day) between Mid Ocean Limited and The
Chase Manhattan Bank
10.14.4 Amendment No. 1 to Credit Agreement (364-Day) between Mid Ocean
Limited and The Chase Manhattan Bank
</TABLE>
64
<PAGE>
<TABLE>
<C> <S>
10.14.5 Loan Agreement between X.L. America, Inc. and Three Rivers
Funding Corporation
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.
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.
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.
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.
10.14.10 First Amendment to Short Term Revolving Credit Agreement between
X.L. Insurance Company, Ltd. and Mellon Bank, N.A.
10.14.11 Second Amendment to Short Term Revolving Credit Agreement between
X.L. Insurance Company, Ltd. and Mellon Bank, N.A.
10.14.12 Third Amendment to Short Term Revolving Credit Agreement between
X.L. Insurance Company, Ltd. and Mellon Bank, N.A.
10.14.13 Fourth Amendment to Short Term Revolving Credit Agreement between
X.L. Insurance Company, Ltd. and Mellon Bank, N.A.
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.
10.14.15 First Amendment to revolving Credit Agreement between X.L.
Insurance Company, Ltd. and Mellon Bank, N.A.
10.14.16 Second Amendment to Revolving Credit Agreement between X.L.
Insurance Company, Ltd. and Mellon Bank, N.A.
11.1 Statement regarding computation of per share earnings.
21.1 List of subsidiaries of the Registrant.
23.1 Consent of PriceWaterhouseCoopers
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 fiscal 1998.
65
<PAGE>
AUDITORS' REPORT ON FINANCIAL STATEMENT
SCHEDULES INCLUDED IN FORM 10-K
Our report on the consolidated financial statements of XL Capital Ltd is
included on page 43 of this Form 10-K in connection with our audits of such
financial statements. We have also audited the related financial statement
schedules listed in the index on pages 59 and 60 of this Form 10-K.
In our opinion, the financial statement schedules referred to above, when
considered in relation to the basic financial statements taken as whole,
present fairly, in all material respects, the information required to be
included therein.
PricewaterhouseCoopers LLP
New York, New York
May 21, 1999
66
<PAGE>
XL CAPITAL LTD
SUPPLEMENTAL SCHEDULE I
CONSOLIDATED SUMMARY OF INVESTMENTS--OTHER THAN
INVESTMENTS IN RELATED PARTIES
November 30, 1998
(U.S. dollars in thousands)
<TABLE>
<CAPTION>
Amount at
which
shown in
Cost or 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, 564,084 $1,580,853 $1,580,853
Non-U.S. sovereign governments............. 401,405 402,374 402,374
All other corporate........................ 3,231,757 3,229,354 3,229,354
----------- ---------- ----------
Total fixed maturities................... $ 5,197,246 $5,212,581 $5,212,581
----------- ---------- ----------
Equity Securities:
Public utilities/transportation............ $ 29,191 $ 35,799 $ 35,799
Banks, trust and insurance companies....... 65,872 82,944 82,944
Industrial, miscellaneous and all others... 900,810 1,009,858 1,009,858
----------- ---------- ----------
Total equity securities.................. $ 995,873 $1,128,601 $1,128,601
----------- ---------- ----------
Short-term investments......................... $ 121,177 $ 121,214 $ 121,214
----------- ---------- ----------
Total investments.............................. $ 6,314,296 $6,462,396 $6,462,396
=========== ========== ==========
</TABLE>
- --------
(1) Investments in fixed maturities and short-term investments are shown at
amortized cost.
67
<PAGE>
XL CAPITAL LTD
SCHEDULE II
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED BALANCE SHEETS--PARENT COMPANY ONLY
For the Years Ended November 30, 1998 and 1997
(U.S. dollars in thousands)
<TABLE>
<CAPTION>
1998 1997
---------- ----------
ASSETS
------
<S> <C> <C>
Portfolio Investments:
Fixed maturities at fair value (amortized cost:
1998--$214,923; 1997--$NIL)......................... $ 216,629 $ --
Short-term investments at fair value (amortized cost:
1998--$9,575; 1997--$NIL)........................... 9,719 --
---------- ----------
Total portfolio investments........................ 226,348 --
Investments in subsidiaries............................ 5,316,554 2,123,993
Investment in affiliate (cost: 1998--$NIL; 1997--
$188,137)............................................. -- 358,423
Investments in limited partnership..................... 18,252 19,259
Accrued investment income.............................. 1,367 --
Other assets........................................... 3,288 3,256
---------- ----------
Total assets....................................... $5,565,809 $2,504,931
========== ==========
<CAPTION>
LIABILITIES
-----------
<S> <C> <C>
Amount due to subsidiaries............................. $ 629,943 $ 24,683
Accounts payable and accrued liabilities............... 117,986 1,118
---------- ----------
Total liabilities.................................. $ 747,929 $ 25,801
========== ==========
<CAPTION>
SHAREHOLDERS' EQUITY
--------------------
<S> <C> <C>
Ordinary shares........................................ $ 1,118 $ 844
Contributed surplus.................................... 2,289,456 290,085
Net unrealized appreciation on investments............. 159,953 188,444
Deferred compensation.................................. (18,104) (11,362)
Retained earnings...................................... 2,385,457 2,011,119
---------- ----------
Total shareholders' equity......................... $4,817,880 $2,479,130
---------- ----------
Total liabilities and shareholders' equity......... $5,565,809 $2,504,931
========== ==========
</TABLE>
See accompanying notes to Consolidated Financial Statements
68
<PAGE>
XL CAPITAL LTD
SCHEDULE II
CONDENSED FINANCIAL INFORMATION OF REGISTRANT--(Continued)
STATEMENT OF INCOME--PARENT COMPANY ONLY
For the Years Ended November 30, 1998, 1997 and 1996
(U.S. dollars in thousands)
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Net investment income............................... $ 2,568 $ 112 $ 568
Net realized gains.................................. 458 -- --
Equity in net income of subsidiaries (Dividends were
$177,900, $186,548 and $302,000 in 1998, 1997 and
1996, respectively)................................ 562,147 617,376 439,361
Equity in net income of affiliate................... 49,878 62,135 59,374
Income from limited partnership..................... 3,599 4,342 --
-------- -------- --------
Total revenues...................................... 618,650 683,965 499,303
Administration expenses............................. 30,987 7,004 4,990
-------- -------- --------
Net income.......................................... $587,663 $676,961 $494,313
======== ======== ========
</TABLE>
See accompanying notes to Consolidated Financial Statements
69
<PAGE>
XL CAPITAL LTD
SCHEDULE II
CONDENSED FINANCIAL INFORMATION OF REGISTRANT--(Continued)
STATEMENT OF CASH FLOWS--PARENT COMPANY ONLY
For the Years Ended November 30, 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.................................. $ 587,663 $ 676,961 $ 494,313
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............................. (574,879) (438,135) (136,106)
Equity in net income of affiliate net of
dividends................................ (31,410) (34,849) (44,592)
Accrued investment income................. (1,367) -- --
Amount due from subsidiaries.............. 605,260 39,091 65,669
Accounts payable and accrued liabilities.. 116,868 478 (1,466)
Amortization of intangible assets......... 10,494 -- --
Amortization of deferred compensation..... 4,361 2,163 1,287
Amortization of discounts on fixed
maturities............................... 335 -- --
--------- --------- ---------
Total adjustments....................... 129,204 (431,252) (115,208)
--------- --------- ---------
Net cash provided by operating
activities............................. 716,867 245,709 379,105
--------- --------- ---------
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................. 49,325 -- --
Purchases of fixed maturities and short-term
investments................................ (472,593) -- --
Other assets................................ (32) (8) (3,081)
Investment in affiliate..................... -- -- (1,620)
Investment in limited partnership........... 1,007 3,376 (12,568)
--------- --------- ---------
Net cash provided (used in) by investing
activities............................. (223,400) 3,368 (17,269)
--------- --------- ---------
Cash flows used in financing activities:
Issuance of restricted shares............... 514 387 695
Proceeds from exercise of options........... 7,538 6,280 6,048
Dividends paid.............................. (150,294) (115,372) (86,145)
Repurchase of treasury shares............... (351,225) (140,372) (282,434)
--------- --------- ---------
Net cash used in financing activities... (493,467) (249,077) (361,836)
--------- --------- ---------
Net change in cash and cash equivalents. -- -- --
--------- --------- ---------
Cash and cash equivalents--beginning of year.. -- -- --
--------- --------- ---------
Cash and cash equivalents--end of year........ $ -- $ -- $ --
========= ========= =========
</TABLE>
See accompanying notes to Consolidated Financial Statements
70
<PAGE>
XL CAPITAL LTD
SCHEDULE IV--REINSURANCE
For the Years Ended November 30, 1998, 1997 and 1996
(U.S. dollars in thousands)
<TABLE>
<CAPTION>
Assumed
Ceded to from
Gross Other other Net
Amount Companies Companies Amount
-------- --------- --------- --------
<S> <C> <C> <C> <C>
1998...................................... $505,263 $134,817 $301,598 $672,044
-------- -------- -------- --------
1997...................................... $418,370 $124,662 $ 22,918 $316,626
-------- -------- -------- --------
1996...................................... $584,585 $132,344 $144,861 $597,102
-------- -------- -------- --------
</TABLE>
71
<PAGE>
XL CAPITAL LTD
SCHEDULE VI
SUPPLEMENTARY INFORMATION
CONCERNING PROPERTY/CASUALTY INSURANCE OPERATIONS
For the Years Ended November 30, 1998, 1997 and 1996
(U.S. dollars in thousands)
<TABLE>
<CAPTION>
Losses and Loss
Expenses Incurred Net
Reserves Reserves Related to Paid Amortization Premiums
Deferred for Losses for Net Net ------------------ Losses of Deferred Written
Acquisition and Loss Unearned Earned Investment Current Prior and Loss Acquisition Prior
Costs Expenses Premiums Premiums Income Year (1) Year (2) Expenses Costs Year (2)
----------- ---------- ---------- -------- ---------- -------- --------- -------- ------------ --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1997............ $97,951 $3,121,739 $1,010,907 $685,200 $279,375 $715,059 $(164,158) $366,475 $88,596 $672,044
------- ---------- ---------- -------- -------- -------- --------- -------- ------- --------
1997............ $22,272 $2,342,254 $ 566,911 $540,653 $216,552 $735,313 $(260,407) $267,227 $46,108 $316,626
------- ---------- ---------- -------- -------- -------- --------- -------- ------- --------
1996............ $30,383 $2,099,096 $ 679,535 $517,892 $198,598 $436,334 $ 14,465 $302,642 $35,556 $597,102
------- ---------- ---------- -------- -------- -------- --------- -------- ------- --------
</TABLE>
72
<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.
XL Capital Ltd
/s/ Brian M. O'Hara
By___________________________________
Brian M. O'Hara
President and Chief Executive
Officer
February 25, 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>
Signatures Title Date
---------- ----- ----
<S> <C> <C>
/s/ Brian M. O'Hara President, Chief Executive May 21, 1999
____________________________________ Officer and Director
Brian M. O'Hara (Principal Executive
Officer)
/s/ Robert R. Lusardi Executive Vice President and May 21, 1999
____________________________________ Chief Financial Officer
Robert R. Lusardi (Principal Financial
Officer and Principal
Accounting Officer)
/s/ Michael P. Esposito, Jr. Director and Chairman of the May 21, 1999
____________________________________ Board of Directors
Michael P. Esposito, Jr.
/s/ Michael A. Butt Director May 21, 1999
____________________________________
Michael A. Butt
/s/ Robert Clements Director May 21, 1999
____________________________________
Robert Clements
/s/ Sir Brian Corby Director May 21, 1999
____________________________________
Sir Brian Corby
/s/ Robert R. Glauber Director May 21, 1999
____________________________________
Robert R. Glauber
/s/ Robert V. Hatcher, Jr. Director May 21, 1999
____________________________________
Robert V. Hatcher, Jr.
</TABLE>
73
<PAGE>
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ Ian R. Heap Director May 21, 1999
____________________________________
Ian R. Heap
/s/ Paul Jeanbart Director May 21, 1999
____________________________________
Paul Jeanbart
/s/ John Loudon Director May 21, 1999
____________________________________
John Loudon
/s/ Robert J. Newhouse, Jr. Director May 21, 1999
____________________________________
Robert J. Newhouse, Jr.
/s/ Robert S. Parker Director May 21, 1999
____________________________________
Robert S. Parker
/s/ Cyril Rance Director May 21, 1999
____________________________________
Cyril Rance
/s/ Alan Z. Senter Director May 21, 1999
____________________________________
Alan Z. Senter
/s/ John T. Thornton Director May 21, 1999
____________________________________
John T. Thornton
/s/ Ellen E. Thrower Director May 21, 1999
____________________________________
Ellen E. Thrower
/s/ John Weiser Director May 21, 1999
____________________________________
John Weiser
</TABLE>
74
