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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K/A
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended OCTOBER 31, 1997
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number 1-14336
MID OCEAN LIMITED
(Exact name of registrant as specified in its charter)
Cayman Islands Not Applicable
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification Number)
Richmond House, 12 Par-la-Ville Road, Hamilton HM 08, Bermuda
(Address of principal executive offices)
Telephone Number: (441) 292 1358
(Registrant's telephone number, including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Title of each class
Class A Ordinary Shares, Par Value $0.20 per Share
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [__]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to the
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 January 12, 1998 was
approximately $2,121 million computed upon the basis of the closing sales price
of the Ordinary Shares on that date. For purposes of this computation, shares
held by directors and officers of the registrant have been excluded. Such
exclusion is not intended, nor shall it be deemed, to be an admission that such
persons are affiliates of the registrant.
As of January 12, 1998 there were outstanding 36,077,267 Class A Ordinary
Shares, 1,190,292 Class B Ordinary Shares and 1,860,000 Class C Ordinary Shares,
each of $0.20 par value, of the registrant.
Documents Incorporated by Reference
Portions of the Registrant's annual report to security holders for the fiscal
year ended October 31, 1997 (the "1997 Annual Report") are incorporated by
reference in Parts II and IV of this Form 10-K.
The registrant's definitive proxy statement filed with the Securities and
Exchange Commission pursuant to Regulation 14A relating to the annual meeting of
shareholders scheduled to be held on March 5, 1998, is incorporated by reference
in Part III of this Form 10-K.
Portions of the Registrant's Registration Statement on Form S-1 (File No.
33-63298) are incorporated by reference in Part I of this Form 10-K.
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INDEX
PART I PAGE
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Item 1 Business......................................................... 1
Item 2 Properties....................................................... 13
Item 3 Legal Proceedings................................................ 13
Item 4 Submission of Matters to a Vote of Security Holders.............. 13
PART II
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Item 5 Market for the Registrant's Common Equity and Related Stockholder
Matters.......................................................... 14
Item 6 Selected Financial Data.......................................... 16
Item 7 Management's Discussion and Analysis of Results of Operations
and Financial Condition.......................................... 16
Item 8 Financial Statements and Supplementary Data...................... 16
Item 9 Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure............................................. 16
PART III
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Item 10 Directors and Executive Officers of the Registrant............... 16
Item 11 Executive Compensation........................................... 16
Item 12 Security Ownership of Certain Beneficial Owners and Management... 16
Item 13 Certain Relationships and Related Transactions................... 16
PART IV
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Item 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K.. 17
Note: All dollar amounts are in United States dollars.
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1
PART I
ITEM 1 - BUSINESS
INTRODUCTION
Mid Ocean Limited ("the Company") is a holding company incorporated in the
Cayman Islands. Its principal offices are located in Bermuda. The Company is the
parent company of Mid Ocean Holdings Limited ("Holdings) which has two wholly
owned subsidiaries; Mid Ocean Reinsurance Company Ltd. ("Mid Ocean Reinsurance")
and Ridgewood Holdings Ltd. ("Ridgewood"). Ridgewood is the Bermuda based
holding company of The Brockbank Group plc ("Brockbank"). The Company, through
its subsidiaries, provides a broad range of reinsurance and insurance products
on a global basis.
Mid Ocean Reinsurance is a leading reinsurer, writing property catastrophe,
property excess of loss, property pro rata, marine and energy, aviation and
satellite and various other risks to insurers and reinsurers on a worldwide
basis. Organized in August 1992, Mid Ocean Reinsurance was the first company
formed specifically to capitalize on the opportunity created by the then
existing supply/demand imbalance for worldwide property catastrophe reinsurance.
This had arisen from several factors; a series of catastrophic events after 1987
causing large losses for existing reinsurers, significant increases in premium
rates and a reduction of property catastrophe reinsurance coverage available to
primary insurance companies in the United States and other significant markets.
Mid Ocean Reinsurance initially focused its efforts primarily on providing
property catastrophe reinsurance to the world's leading insurers, many of whom
are now reinsureds of Mid Ocean Reinsurance. Since the beginning of 1995
however, premium rates across most classes of business and in most markets have
declined where a lack of significant losses and an increased supply of
reinsurance coverage available have caused pricing pressures. In order to
diversify its spread of business, Mid Ocean Reinsurance has written other
primarily short tail lines that are not necessarily catastrophe-related. Mid
Ocean Reinsurance assumes risks which are diversified both geographically and
across ceding companies and which generally have aggregate limits and varying
attachment points. Property catastrophe gross written premiums represented
approximately 46% of Mid Ocean Reinsurance total gross written premiums in 1997.
Property catastrophe loss experience, as well as loss experience on many of the
other lines of business Mid Ocean Reinsurance writes, is generally characterized
as low frequency but high severity in nature and may result in volatility in the
Company's financial results for any fiscal quarter or year.
In August 1995, Mid Ocean Reinsurance opened a branch office in London which
writes marine and energy, and aviation excess of loss reinsurance. In August
1996, Mid Ocean Reinsurance Consulting GmbH was established, a wholly owned
subsidiary of Mid Ocean Reinsurance located in Munich, Germany, which is its
Continental European contact office. In September 1996, Mid Ocean Reinsurance
opened a branch office in Singapore which writes treaty, facultative, and a
small amount of casualty business.
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. In December 1995,
Mid Ocean Reinsurance acquired 51% of Brockbank. In August 1997, the Company
acquired the remaining 49% of Brockbank for an estimated cost of $ 144.4 million
in the form of cash, loan notes and issued shares of the Company. The two
corporate syndicates commenced underwriting with effect from January 1, 1996 and
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. In 1996 they had an
aggregate premium limit (i.e. underwriting capacity) of approximately $155
million. This was increased to approximately $230 million effective January 1,
1997 and approximately $340 million effective January 1, 1998. Capacity under
management by Brockbank was
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approximately $840 million for 1997 and will be approximately $896 million in
1998. The managing agency receives fees and commissions in respect of the
underwriting services it provides to the syndicates. Mid Ocean Reinsurance has,
from time to time, provided quota share reinsurance to the syndicates managed by
Brockbank.
The Company will continue to seek, on a selected basis, additional business
opportunities with the goal of enhancing shareholder value.
Mid Ocean Reinsurance is a registered Bermuda reinsurance company and is subject
to regulation and supervision in Bermuda, the United Kingdom, Germany and
Singapore. Brockbank is subject to United Kingdom and Lloyd's regulations and
supervision.
Mid Ocean Reinsurance is not registered or licensed as an insurance company in
any jurisdiction in the United States of America ("United States" or "US").
Brockbank, via Lloyd's, is a licensed insurer in the states of Illinois,
Kentucky and the US 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.
The Company's fiscal year end is October 31. References to 1997, 1996 and 1995
refer to the fiscal years ended October 31, 1997, 1996 and 1995 respectively.
Brockbank's fiscal year end is December 31. Results of operations relating to
Brockbank for the nine month period from January 1, 1996, (the date of
acquisition of a 51% interest) to September 30, 1996 are included in the
Company's fiscal year end October 31, 1996 whereas results of Brockbank's
operations for the twelve month period ended September 30, 1997 are included in
the Company's fiscal year end October 31, 1997.
For the years ended October 31, 1997, 1996 and 1995, the Company reported net
premiums written of $505.5 million, $525.7million and $435.0 million
respectively. The following table sets forth the Company's net premiums written
by lines of business:
<TABLE>
<CAPTION>
($ in millions) 1997 1996 1995
-------------------------------------------------------------
Net Net Net
Premiums Percent Premiums Percent Premiums Percent
Written of Total Written of Total Written of Total
-------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Property Catastrophe $146.1 28.9% $162.5 30.9% $204.4 47.0%
Other Property 93.4 18.5% 131.8 25.1% 127.0 29.2%
Marine and Energy 40.7 8.0% 53.3 10.1% 59.3 13.6%
Aviation and Satellite 37.6 7.4% 38.2 7.3% 32.6 7.5%
Corporate syndicates 181.3 35.9% 125.6 23.9% -- -%
Other 6.4 1.3% 14.3 2.7% 11.7 2.7%
------ ------ ------ ------ ------ ------
Total $505.5 100.0% $525.7 100.0% $435.0 100.0%
------ ------ ------ ------ ------ ------
</TABLE>
PROPERTY CATASTROPHE REINSURANCE
Mid Ocean Reinsurance's property catastrophe reinsurance account is generally
"all risk" in nature. Mid Ocean Reinsurance is therefore exposed to losses from
sources as diverse as windstorms, earthquakes, freezes, riots, floods,
industrial explosions, fires or any number of other potential disasters. In
accordance with market practice, Mid Ocean Reinsurance's property reinsurance
policies generally exclude certain risks such as war, nuclear contamination or
radiation. Mid Ocean Reinsurance's predominant exposure under such coverage is
to property damage. However, other risks, including business interruption, death
and injury under workers compensation policies and other non-property losses may
also be covered under a property reinsurance contract when arising from a
covered peril. Property catastrophe reinsurance provides coverage on an excess
of loss basis when aggregate losses and loss adjustment expenses from a single
occurrence of a covered peril exceed the attachment point specified in the
policy. Some of Mid Ocean Reinsurance's property catastrophe contracts limit
coverage to one occurrence in any policy year, but most contracts generally
provide for one reinstatement. Property
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catastrophe premium rates, measured on an exposure adjusted basis were down in
1997 by approximately 12% on major United States risks. The United Kingdom,
Japan and Australian markets saw rates decline between approximately 15% and
20%.
The table below presents Mid Ocean Reinsurance's property catastrophe net
premiums written by geographic area for the years ended October 31, 1997, 1996
and 1995. The table also includes net premiums written with respect to
retrocessions which cannot be allocated geographically.
<TABLE>
<CAPTION>
($ in millions) 1997 1996 1995
-------------------------------------------------------------
Net Net Net
Premiums Percent Premiums Percent Premiums Percent
Written of Total Written of Total Written of Total
-------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Geographic Area:
United States (1) $ 77.6 58.6% $ 74.1 51.4% $ 87.1 49.2%
United Kingdom 15.5 11.7% 19.4 13.5% 25.5 14.4%
Japan 8.7 6.6% 12.3 8.5% 18.8 10.6%
Worldwide 8.3 6.3% 4.8 3.3% 8.5 4.8%
Continental Europe 7.2 5.4% 11.0 7.6% 11.6 6.6%
Australasia 8.5 6.4% 13.1 9.1% 14.4 8.2%
Caribbean 4.5 3.4% 5.4 3.7% 6.2 3.5%
Other 2.2 1.6% 4.0 2.9% 4.9 2.7%
------ ------ ------ ------ ------ ------
Sub-Total 132.5 100% 144.1 100% 177.0 100%
------ ------ ------
Retrocessions 13.6 18.4 27.4
------ ------ ------
Total Property Catastrophe $146.1 $162.5 $204.4
====== ====== ======
</TABLE>
(1) 1997 net premiums written included $13 million relating to a contract with
the California Earthquake Authority which covers the 1997 and 1998
underwriting years.
OTHER PROPERTY REINSURANCE
Other property reinsurance written by Mid Ocean Reinsurance includes property
risk excess 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, similar to
property catastrophe reinsurance.
Property risk excess contracts have traditionally provided for unlimited
reinstatement, sometimes with payment of an additional premium. Most of the risk
excess treaties Mid Ocean Reinsurance participates in have limited
reinstatements and contain a per event limit on Mid Ocean Reinsurance's
liability, which limits Mid Ocean Reinsurance's per event exposure on its risk
excess business in the event of a catastrophe of the type to which property
catastrophe reinsurance responds.
Mid Ocean Reinsurance's property pro rata account includes proportional
reinsurance of direct written property insurance. Mid Ocean Reinsurance
considers this business to be related to its catastrophe and other property
exposures. In proportional reinsurance, Mid Ocean Reinsurance 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
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instances, Mid Ocean Reinsurance may be entitled to the benefit of other
reinsurance, known as common account reinsurance, purchased by the ceding
company on an account reinsured by Mid Ocean Reinsurance on a proportional
basis.
MARINE AND ENERGY
Mid Ocean Reinsurance'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. Premium rates, both at an insurance and reinsurance level, have been
under significant pricing pressure during 1997.
AVIATION AND SATELLITE
Mid Ocean Reinsurance'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 Mid
Ocean Reinsurance under this portfolio are acquired mostly through proportional
reinsurances of specialist underwriters. The aerospace market remains
competitive, both at an insurance and reinsurance level.
CORPORATE SYNDICATES
Brockbank has two wholly owned subsidiary companies who each solely provide
capital to support the underwriting of two dedicated Lloyds syndicates, known as
the corporate syndicates. Brockbank also has two wholly owned subsidiary
companies that are Lloyds managing agencies who provide underwriting and
administrative services to five syndicates that they manage. Two of the
syndicates they manage are the corporate syndicates and the other three
syndicates have capital provided by non related, third parties, known as Names.
Premiums are written by the corporate syndicates in parallel alongside the other
syndicates managed by Brockbank and the underwriting split is determined
annually based upon each syndicates respective capital or capacity available.
Corporate syndicate number 1209 writes property, marine and energy, aviation and
satellite, professional indemnity, and other specialty 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.)
OTHER
Other reinsurance written by Mid Ocean Reinsurance includes nuclear, accident,
fidelity and professional indemnity.
OUTWARD RETROCESSIONS - REINSURANCE PROTECTIONS PURCHASED
For the years ended October 31, 1997, 1996 and 1995, Mid Ocean Reinsurance
participated in limited retrocessions. Initially the majority of such
retrocessions originated from common account reinsurance on assumed business.
However in 1997 and 1996, Mid Ocean Reinsurance purchased specific reinsurance
protection covering certain aspects of its book of business.
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
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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.
MARKETING
Mid Ocean Reinsurance utilizes approximately 55 non-US brokers to market
substantially all of its business on a worldwide basis. The broker is an
integral part of Mid Ocean Reinsurance's strategy to become a leading reinsurer.
Mid Ocean Reinsurance has established strong relationships with brokers by
providing their respective clients with property catastrophe and other
reinsurance that is supported by a sufficient level of capital and surplus. Mid
Ocean Reinsurance is able to market cost-effectively and limit the amount of
employees required to market its products. The Company believes that by
maintaining close relationships with brokers, it obtains access to a broad range
of potential insureds and reinsureds. Business submissions to Mid Ocean
Reinsurance are underwritten in Mid Ocean Reinsurance's offices in Bermuda,
London or Singapore.
Brockbank markets business through approximately 102 brokers excluding personal
lines, which are written through a significant number of brokers. The Brockbank
business is underwritten in the United Kingdom.
The Company writes a significant amount of business through subsidiaries of J&H
Marsh and McLennan, Incorporated.
The following table sets forth the percentage of the Company's business placed
in the years ended October 31, 1997, 1996 and 1995 through each broker and its
affiliates placing more than 10% of the Company's gross premiums written:
<TABLE>
<CAPTION>
Name (4) Year Ended Year Ended Year Ended
October 31, 1997 October 31, 1996 October 31, 1995
---------------- ---------------- ----------------
<S> <C> <C> <C>
J&H Marsh and McLennan, Incorporated (1) (3) 21.3% 25.5% 40.9%
Aon Corporation (2) (3) 13.0% 13.1% 13.5%
Willis Corroon Group 11.1% 8.6% 6.71%
</TABLE>
(1) J&H Marsh & McLennan, Incorporated and Marsh & McLennan Risk Capital
Holdings, Ltd., (one of the Company's principal shareholders) are both
subsidiaries of Marsh & McLennan Companies, Incorporated. During 1997,
Marsh & McLennan, Incorporated acquired Johnson & Higgins and several other
companies.
(2) During 1997, Aon Corporation acquired Alexander & Alexander Services, Inc.
and Bain Hogg and several other companies. For 1996, the percentage of
business placed by Aon Corporation, Alexander & Alexander Services, and
Bain Hogg was 2.9%, 5.2% and 2.3% respectively. In 1995, the amounts were
3.4%, 6.5% and 2.7% respectively.
(3) The percentages shown in the table for 1997 reflect the business placed by
the combined entities and their affiliates for the entire year.
(4) Note that 1997 and 1996 include Brockbank whereas 1995 was Mid Ocean
Reinsurance only.
UNDERWRITING
The Company employs a disciplined, 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, Mid Ocean Reinsurance has developed
underwriting guidelines under which it generally limits the amount of exposure
it will directly
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underwrite for any one reinsured and the amount of the aggregate exposure to
catastrophe losses in any geographic zone. Mid Ocean Reinsurance 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 Mid Ocean
Reinsurance's zones are subject to periodic review and change. Mid Ocean
Reinsurance also generally seeks an attachment point for its property
catastrophe reinsurance anticipated to be high enough to produce a low frequency
of loss. Mid Ocean Reinsurance 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, Mid Ocean Reinsurance 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 risks is performed by the active
underwriter, the class underwriters and senior underwriting assistants.
Underwriting authority limits are agreed between the active underwriter, the
director of underwriting and the class underwriter. All risks are reviewed by
one of the two deputy underwriters.
CLAIMS ADMINISTRATION
Claims arising from contracts written by Mid Ocean Reinsurance in Bermuda are
managed in Bermuda by its own claims department. Loss notifications are received
from brokers, reviewed and entered into a claims database and loss reserves are
established for Mid Ocean Reinsurance'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 Mid Ocean
Reinsurance's London branch are entered into a claims databases held 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 then it will act with its underwriters
and claims adjusters in dealing with the broker or insured on behalf of itself
and the following market in dealing with the broker and/or insured for any
particular claim. This may involve appointing attorneys and/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 their two
tele-servicing centres in Cardiff and Swansea, Wales. The majority of accidental
damage claims are handled by Admiral's national network of 135 approved
repairers, 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.
RESERVES
Under United States generally accepted accounting principles, the Company is not
permitted to establish loss reserves until the occurrence of an event which may
give rise to a claim. Once such an event occurs, the Company establishes
reserves based upon estimates of total losses incurred by the insured or
reinsured as a result of the event and the Company's estimate of it's portion of
such loss. Such reserves will be adjusted as the Company receives notices of
claims and proofs of loss from insureds and reinsureds and as estimates of
severity of damages and the Company's share of the total loss are revised.
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Generally, reserves are established without regard to whether the claim may
subsequently be contested by the Company. The Company's policy is to establish
reserves for reported losses based upon reports received from insureds and
reinsureds supplemented by the Company's case reserve estimates. Loss reserves
represent estimates of what the Company ultimately expects to pay on claims at a
given time, based on facts and circumstances then known, and it is possible that
the ultimate liability may exceed or be less than such estimates. During the
loss settlement period, it often becomes necessary to refine and adjust the
estimates of liability on a claim either upward or downward. Even after such
adjustments, the ultimate liability may exceed or be less than the revised
estimates.
The Company establishes reserves for incurred but not reported losses ("IBNR").
In determining the IBNR portion of loss and loss expenses for the year, the
Company classifies the business written into segments that could reasonably be
expected to have similar loss characteristics. Reporting patterns and initial
expected loss ratios are developed based upon available industry data, actual
experience, knowledge of the business written by the Company and general market
trends in the reinsurance industry. The Company has relied on and consistently
applied the Bornhuetter-Ferguson incurred loss actuarial method for estimating
its loss reserves. Due to a relatively low level of losses as compared to
historical industry experience, actual losses have not developed in accordance
with initial estimates made by management. This has resulted in the favorable
loss development and the release of loss reserves established in prior years.
The Company employs its own actuaries who develop the IBNR loss reserves. In
addition, Mid Ocean Reinsurance's IBNR loss reserves undergo a review by
independent consulting actuaries.
Mid Ocean Reinsurance expects that most claims under its property catastrophe
and property risk excess treaties will generally become known and ascertainable
within approximately 18 to 24 months from the date of the occurrence giving rise
to a claim. Brockbank expects that claims under a significant majority of its
policies, with the exception of motor, will generally become known and
ascertainable within 36 months of the date of the occurrence giving rise to a
claim. The motor business claims will generally be known and paid within 12
months of the date of the occurrence giving rise to the claim.
The Company incurred losses and loss expenses for the years ended October 31,
1997, 1996 and 1995 of $216.2 million, $211.9 million and $198.7 million net of
reinsurance recoveries of $ 26.1 million, $4.6 million and $1.4 million
respectively. The only significant catastrophe loss events during these three
years affecting the Company was in 1995 with the Great Hanshin, Kobe earthquake
where the Company established a $5.0 million provision and a $21.5 million
provision in respect of Hurricanes Luis and Marilyn. The Company paid net losses
of $159.3 million during the year ended October 31, 1997 compared to $118.6
million and $84.7 million in 1996 and 1995 respectively. The lack of significant
loss events during 1997 and 1996 together with a release of loss reserves
established in prior years, has contributed to lower loss ratios (net incurred
losses as a percentage of net earned premium) for Mid Ocean Reinsurance. This
reduction is offset by higher incurred loss ratios applicable to business
written by the corporate syndicates in 1997 and 1996. Net incurred loss and loss
expense ratios for the Company were 44.4%, 48.6% and 52.4% for the 1997, 1996
and 1995 years respectively.
At fiscal year end 1997, net loss reserves amounted to $479.2 million compared
to $422.3 million at fiscal year end 1996. Net reserves for IBNR losses were
$351.0 million and $318.0 million respectively.
INVESTMENTS
The Finance Committee of the Board of Directors is responsible for the
establishment of the Company's investment policy consistent with the Company's
strategies, goals and objectives. The investment policy is reviewed with and
approved by the Board of Directors. Mid Ocean Reinsurance has developed specific
investment guidelines for the management of its investment portfolio. Although
these guidelines stress diversification of risks and conservation of principal
and liquidity, investments are subject to market-wide risks and fluctuations, as
well as to risks inherent in particular securities. The primary objective of the
portfolio, as set forth in the guidelines, is to preserve the capital assets of
Mid Ocean Reinsurance's while achieving a total return commensurate with market
conditions. These guidelines, which are subject to change at the discretion of
the Company's Board of Directors, are discussed below. Mid Ocean Reinsurance
letter of credit facility also contains certain restrictions on the type of
investments included in the portion of the portfolio pledged to secure such
facility.
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The Company invests in both fixed maturity and equity securities. At October 31,
1997, total investments available for sale were $1,546.8 million, of which $23.5
million or 1.5% were in equity securities and $1,523.3 million or 98.5% were in
fixed maturities. At October 31, 1996, the Company did not hold any equity
securities. Total returns, measured on a market value basis, for the year ended
October 31, 1997 were 14.2% on equity securities and 8.2% on fixed maturities.
Total returns for the year ended October 31, 1996 were 5.9%.
FIXED MATURITY SECURITIES
At fiscal year end 1997, approximately 59% of the Company's fixed maturity
investment portfolio was managed internally. In addition, Mid Ocean Reinsurance
has entered into investment management agreements (the "Investment Management
Agreements") with the following companies: Loomis Sayles and Company Inc, Miller
Anderson and Sherrerd LLP and Mercury Asset Management (collectively, the
"Investment Managers").
Under the Investment Management Agreements, the Investment Managers are subject
to Mid Ocean Reinsurance's investment guidelines. Mid Ocean Reinsurance is
obligated to pay the Investment Managers fees based on the value of the assets
under management. The performance of, and the fees paid to, the Investment
Managers under the Investment Management Agreements are reviewed periodically by
management and the Finance Committee of the Board of Directors.
At October 31, 1997 approximately 84.7% of the Company's investment debt
portfolio was in US Government securities or in obligations rated A or better by
Moody's Investors Service Inc. or Standard & Poors Corporation. No more than 5%
of Mid Ocean Reinsurance's investment debt portfolio will generally be invested
in the securities of any single issuer with the exception of securities issued
or ultimately guaranteed by sovereign governments or agencies, including
supranational agencies.
At October 31, 1997, 1996 and 1995, the weighted average duration of the
portfolio was 3.7 years for each of the three years. The annualized effective
yield calculated on the average of the beginning and ending values of
investments, net of pending trades, and cash and cash equivalents was 6.5%, 6.2%
and 6.4% for fiscal years 1997, 1996 and 1995 respectively.
The Company's primary reinsurance risk exposures and premiums receivable are
denominated in US Dollars, British Pounds and Japanese Yen. The investment debt
portfolio may, from time to time, be partially invested in non-US Dollar
component currencies of its expected liability profile, thereby reducing, to
some extent, the currency exposure on the underlying reinsurance risks.
EQUITY SECURITIES
During 1997, Mid Ocean Reinsurance invested in equity securities for the first
time, as permitted under the investment guidelines which allow up to a maximum
15% of the total portfolio. At October 31, 1997 the Company held $ 23.5 million
of equity securities.
Investments, both fixed maturity and equity securities, held by Brockbank are
monitored by an investment committee. Asset positions and investment strategy
are communicated to the Board of Directors of Brockbank on a weekly basis. The
investment committee approve significant strategy changes and monitors
investment results against set targets. The investment portfolio returns are
monitored against Lloyd's investment rules and guidelines.
The Company has classified its investment portfolio as available for sale and
consequently the portfolio is carried at fair value in accordance with the
Financial Accounting Standards Board Statement of Financial Accounting Standard
("SFAS") 115.
For additional information regarding the investment portfolio see note 3 to the
consolidated financial statements included in the 1997 Annual Report.
<PAGE> 11
9
REGULATION
Bermuda
The Insurance Act of 1978 (as amended by the Insurance Amendment Act 1995) and
related regulations (the "Act"), regulates the business of Mid Ocean
Reinsurance. 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. The Act provides for four classes of insurance
company. Mid Ocean Reinsurance is designated as a Class 4 insurer which is the
designation for the largest companies requiring capital and surplus in excess of
$100 million. Each class 4 insurer must appoint a loss reserve specialist, whom
must be approved by the minister, to review and report on the loss reserves of
the insurer on an annual basis.
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 Holdings which relies on dividends from direct
and indirect subsidiaries. The payment of such dividends is restricted by
applicable law including Bermuda and United Kingdom insurance law and
regulations, including those promulgated by the Society of Lloyds. Mid Ocean
Reinsurance's statutory capital and surplus was approximately $1,200,000 at
October 31, 1997 and the minimum required statutory capital and surplus was
approximately $162,000 at October 31, 1997. Currently there are no effective
statutory restrictions on the payments of dividends from retained earnings by
Mid Ocean Reinsurance or the Company as the minimum required statutory capital
and surplus is satisfied by share capital and additional paid-in-capital.
United States
The insurance laws of each state of the United States and of many foreign
countries regulate the sale of insurance within their jurisdiction by alien
insurers, such as Mid Ocean Reinsurance. The Company and its insurance
subsidiaries, excluding its Lloyd's operations, are not admitted to do business
as reinsurers in any jurisdiction in the U.S. Each state in the U.S. licenses
insurers and prohibits, with some exceptions, the sale of insurance products by
non-admitted reinsurers within their applicable jurisdictions.
Mid Ocean Reinsurance conducts its reinsurance business from its offices in
Bermuda, London and Singapore. All of Mid Ocean Reinsurance's US clients are
obtained through non-U.S. insurance brokers and non-U.S. affiliates of U.S.
insurance brokers. All insurance policies are issued and delivered and premiums
are received in Bermuda, London and Singapore. Mid Ocean Reinsurance believes it
is not in violation of the insurance laws of any state in the US or any foreign
country.
From time to time, various proposals for federal legislation within the United
States have been circulated which could require Mid Ocean Reinsurance to, among
other things, register as a surplus lines insurer. Mid Ocean Reinsurance does
not believe such legislation would have a material impact on the ability of Mid
Ocean Reinsurance to conduct its business.
Brockbank is required to deposit funds in the United States to cover a
proportion of its gross liabilities for certain US based risks. At October 31,
1997 and 1996, $15.3 million and $2.0 million respectively, was held on deposit
in the United States to cover such liabilities.
United Kingdom
London Branch Office
The United Kingdom Department of Trade and Industry ("DTI") regulates
reinsurance entities that are "effecting and carrying on" insurance business in
the United Kingdom. Mid Ocean Reinsurance, through its London branch, "effects
and carries on" business in the United Kingdom and is therefore regulated by the
DTI.
Mid Ocean Reinsurance is required to maintain a margin of solvency and prepare a
global return to the DTI. These DTI regulations do not restrict payment of
dividends by Mid Ocean Reinsurance or the Company.
<PAGE> 12
10
The DTI requires all insurance entities to prepare an annual audited return to
be submitted in accordance with the Insurance Companies Act 1982 and to maintain
a minimum solvency margin, based on a number of methods, throughout the year.
The annual returns filed with the DTI include the results of Mid Ocean
Reinsurance and its branch operations in London and Singapore. There are no
specific requirements relating to risk based capital or other financial ratios.
Lloyd's
As a result of the Brockbank acquisition, 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. 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.
All Lloyds managing agencies must comply with Lloyds' Underwriting Agents
Bye-laws which requires solvency margins to be maintained based upon the levels
of share capital and net assets.
Profits of the corporate syndicates for any one underwriting year cannot be
distributed until after the year of account "closes", which is normally three
years after it commences, in accordance with Lloyds Agency Agreement Bye-laws
and Syndicates Accounting Bye-laws.
Currently, the above regulations would not effectively restrict Brockbank or the
Company from the payment of dividends.
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.
Singapore
The Monetary Authority of Singapore ("MAS") regulates reinsurance entities
operating in Singapore in accordance with the Insurance Act (CAP.142) and
related regulations. Mid Ocean Reinsurance's Singapore branch is regulated by
the MAS, which includes quarterly reporting and solvency margins to be
maintained but which do not restrict payment of dividends by Mid Ocean
Reinsurance or the Company. Quarterly and annual audited returns must be filed
and in addition, margins of solvency must be maintained for both Singapore and
offshore business based on certain calculations. The return is based upon the
Singapore branch results.
<PAGE> 13
11
Germany
The Company has established, for marketing purposes, a representative office in
Munich, Germany. However, all underwriting operations continue to be conducted
in Bermuda, Singapore and the United Kingdom.
TAX MATTERS
United States
Corporate Income Tax
The Company is a Cayman Islands company and has never paid United States
corporate income taxes on the basis that it is not engaged in a trade or
business in the United States.
Related Person Insurance Income
Each US Shareholder of the Company who owns shares (directly or through foreign
entities) on the last day of the Company's fiscal year may have to include in
such shareholder's gross income for US tax purposes a proportionate share of the
Company's "related person insurance income" ("RPII") if the RPII of the
Company's insurance and reinsurance subsidiaries, determined on a gross basis,
is 20% or more of each insurance and reinsurance subsidiary's gross insurance
income in such fiscal year and 20% or more of the total voting power or value of
each insurance and reinsurance subsidiary's common stock is held by insureds or
reinsureds or persons related thereto. RPII is income attributable to insurance
policies where the direct or indirect insureds are US shareholders or are
related to US shareholders. RPII is included in a US shareholder's gross income
for US tax purposes regardless of whether such shareholder is a policyholder.
While there can be no assurance, the Company does not believe 20% or more of the
gross insurance income of its insurance and reinsurance subsidiaries for fiscal
1997 constituted RPII and does not anticipate that 20% or more of its insurance
and reinsurance subsidiaries gross insurance income in future taxable years will
constitute RPII. For a more detailed discussion of RPII and other tax matters
pertaining to an investment in the Company's Ordinary Shares, reference is
hereby made to the section entitled "Certain Tax Considerations" in the
Company's Registration Statement on Form S-1 (File No. 33-63298), shown in
Exhibit 99-1.
Cayman Islands
Under current Cayman Islands law, the Company is not required to pay any taxes
in the Cayman Islands on either income or capital gains. The Governor in Council
has issued an undertaking that the Company will be exempted from Cayman Islands
income or capital gains tax until the year 2013.
Bermuda
Under current Bermuda law, neither the Company nor Mid Ocean Reinsurance is
required to pay any taxes in Bermuda on either income or capital gains. The
Company and Mid Ocean Reinsurance have received an undertaking from the Minister
of Finance in Bermuda that in the event of any such taxes being imposed, the
Company and Mid Ocean Reinsurance will be exempted from income or capital gains
taxation until the year 2016.
United Kingdom
Lloyd's Names are required to pay US income tax on US connected income ("US
income") written by Lloyd's syndicates on 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 UK corporation tax
credits for any US income tax incurred up to the value of the equivalent UK
corporation income tax charge.
<PAGE> 14
12
Brockbank is subject to UK corporation tax and value added tax. The Company's
London branch has been advised that it is deemed to be doing insurance business
in the UK and therefore is subject to taxation in the UK on business written in
the UK.
With effect from October 1, 1994, the UK imposed an insurance premium tax on
that portion of policies relating to certain UK risks. Brockbank, including its
syndicates, are registered to collect and pay this tax on behalf of UK domiciled
policyholders.
Singapore
Profits of the Singapore branch are subject to Singapore corporation taxes.
Germany
The German subsidiary is subject to taxation in Germany. However under its
current role as a consulting operation it is not expected to generate any
taxable revenue.
EMPLOYEES
At October 31, 1997 Mid Ocean Reinsurance employed a total of 65 persons and
Brockbank (including only its direct operations) employed approximately 200
persons. None of these employees is represented by a labor union. Mid Ocean
Reinsurance and Brockbank believe that relations with their employees are
excellent.
COMPETITION
The reinsurance industry and the Lloyd's market are highly competitive. Mid
Ocean Reinsurance competes with US and other insurers and reinsurers, some of
which have greater financial, marketing and management resources while Brockbank
competes with other Lloyd's market managing agencies, Lloyd's syndicates, London
market companies and other insurers and reinsurers. Competition in the types of
business that Mid Ocean Reinsurance and Brockbank underwrite is based on many
factors, including the perceived financial strength of the underwriting
syndicate or the reinsurer, pricing and other terms and conditions, services
provided, ratings assigned by independent rating organizations, speed of claims
payment and reputation and experience in the line of reinsurance to be written.
Lloyd's of London is a long established insurance marketplace, where many varied
forms of insurance and reinsurance are sold by syndicates, which are annual
joint ventures of Names. Participation as a Name on a syndicate carries with it
unlimited liability for the Name's share of any insurance losses incurred by the
syndicate (each Name participating severally). In 1994, the rules surrounding
participation were changed to allow limited liability "corporate names" to enter
the Lloyd's marketplace as capital providers.
Several of the underwriting years of the late 1980s and early 1990s proved to be
particularly unprofitable for many of the syndicates operating at Lloyd's. This
proved to be financially disastrous for some of the Names on the affected
syndicates due to the unlimited liability of their participation. Lloyd's
governing body sought to implement a reconstruction and renewal plan to allow
the market to continue and in August 1996 this plan was formally approved by the
required parties. A new company, Equitas, was authorized to reinsure the
liabilities of the 1992 and prior years of account of all syndicates at Lloyd's.
Funding came from a variety of sources including the premiums on the liabilities
assumed by Equitas as well as a series of levies charged to entities that had
historically provided services to the Lloyd's insurance market (including
managing agencies and insurance brokers).
Participation in selected syndicates in the Lloyd's insurance market provides
the Mid Ocean Reinsurance with access to various lines of business providing the
opportunity to diversify its insurance risk profile to markets to which it would
otherwise not have access. The Company's participation through the dedicated
corporate syndicates limits the liability of the Company.
The Company has received a rating of A+ (Superior) from A.M. Best Company Inc.
("A.M. Best") and an AA (Excellent) claims paying rating from Standard & Poor's
Corporation ("S&P"). A.M. Best and S&P ratings are based upon factors relevant
to policyholders, agents and intermediaries and are not directed
<PAGE> 15
13
toward the protection of investors. Such ratings are not recommendations to buy,
sell or hold securities.
S&P ratings are broadly divided into two categories: 'secure' and 'vulnerable'.
Rating categories from 'AAA' to 'BBB' are classified as 'secure' and are used to
indicate insurers whose financial capacity to meet policyholder obligations is
viewed on balance as sound. Rating categories from 'BB' to 'CC' are classified
as 'vulnerable' and are used to indicate insurers whose financial capacity to
meet policyholder obligations is viewed as vulnerable to adverse economic and
underwriting conditions. The Company's AA rating is classified as excellent
financial security with the capacity to meet policyholder obligations is strong
under a variety of economic and underwriting conditions.
A.M. Best ratings are also broadly divided into two categories: 'secure' and
'vulnerable'. Rating categories from 'A++' to 'B+' are classified as 'secure'
and are used to indicate insurers whose financial strength, operating
performance and marked profile ranges from superior to very good and whose
ability to meet their ongoing obligations to policyholders ranges from very
strong to good. Rating categories from 'B' to 'D' are classified as 'vulnerable'
and are used to indicate insurers whose financial strength, operating
performance and market profile range from fair to poor and whose current
obligations to policy holders range from ability to meet to may not have an
ability to meet. There are also three additional ratings; 'E' for under
regulatory supervision, 'F' for in liquidation and 'S' for rating suspended. The
Company's A+ rating is classified as superior which is assigned to companies
which have, on balance, superior financial strength, operating performance and
market profile and have a very strong ability to meet their ongoing obligations
to policyholders.
ITEM 2 - PROPERTIES
Mid Ocean Reinsurance leases office space in Richmond House, Hamilton, Bermuda,
where the Company's principal offices are also located. Mid Ocean Reinsurance
also leases office space in the London Underwriting Centre, London, England, at
which its London branch office is located. In addition, Mid Ocean Reinsurance
leases office space at 6 Raffles Quay, John Hancock Tower, Singapore at which
its Singapore branch is located. Office space is also leased at Bavariaring 44,
Munich, Germany where Mid Ocean Reinsurance Consulting GmbH is located.
Brockbank leases office space at Fitzwilliam House and Rood Lane, London where
its principal offices are located. Other Brockbank operations lease space in
Cardiff and Swansea, Wales and Haywards Heath, England.
ITEM 3 - LEGAL PROCEEDINGS
The Company is subject to litigation and arbitration in the ordinary course of
its business.
While any proceeding contains an element of uncertainty, management presently
believes the outcome thereof will not have a material adverse effect on the
Company.
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.
EXECUTIVE OFFICERS OF THE COMPANY
The table sets forth the names, ages and titles of the persons who are the
executive officers of the Company and its subsidiaries:
<TABLE>
<CAPTION>
Name Age Position
- ---- --- --------
<S> <C> <C>
Robert J. Newhouse, Jr. 72 Chairman of the Board
Michael A. Butt 55 President & Chief Executive Officer
Mark E. Brockbank 45 Chief Executive Officer of The Brockbank Group plc
Charles F. Hays 51 Senior Vice President, Chief Financial & Administrative Officer
Henry C. V. Keeling 42 President, Chief Operating & Underwriting Officer
of Mid Ocean Reinsurance Company Ltd.
</TABLE>
<PAGE> 16
14
Robert J. Newhouse, Jr. serves as Chairman of the Board of the Company and
Holdings. He served as Vice Chairman of Marsh & McLennan Companies Inc., as a
member of the Office of the Chairman of Marsh & McLennan Companies Inc. and as a
member of the Executive Committee of Marsh & McLennan Companies Inc. until 1990.
Mr. Newhouse was elected a director of Marsh & McLennan Companies Inc. in 1971,
Executive Vice President in 1974 and President in 1976. He was elected Vice
Chairman of Marsh & McLennan Companies Inc. in 1988. Mr. Newhouse also serves as
a director of Trident Corp.
Michael A. Butt serves as President & Chief Executive Officer of the Company
(since May 1993) and has been a director since June 1993. Mr. Butt also is the
President & Chief Executive Officer and a director of Holdings. Mr. Butt was
appointed Chairman of the Board of Mid Ocean Reinsurance in September 1997 in
addition to his position of Chief Executive Officer. Mr. Butt has served as a
director of the Instituto Nazionale di Assicurazioni ("INA"), Rome from November
1993 to December 1997, and the Bank of N. T. Butterfield & Son, Limited since
October 1996. From 1992 to April 1993, Mr. Butt served as director of Phoenix
Securities Limited, a private investment banking firm based in London. From 1987
to 1992 he was a director of BAT Industries and Chairman and Chief Executive
Officer of Eagle Star Holdings Plc and Eagle Star Insurance Company. From 1982
to 1986, Mr. Butt was Chairman of Sedgwick Limited and Vice Chairman of Sedgwick
Group Plc.
Mark E. Brockbank is Vice Chairman of Holdings and Director & Chief Executive
Officer of The Brockbank Group plc. Mr. Brockbank is also Chairman of Admiral
Insurance Services Ltd., Brockbank Personal Lines Ltd and Active Underwriter of
syndicate 861. Mr. Brockbank has been employed at Lloyd's since 1974 when he
joined Willis Faber Dumas as a Marine broker. He became underwriter of syndicate
861 in 1983. He was appointed a Director of Brockbank Syndicate Management Ltd
in 1983 and of The Brockbank Group plc in 1988. He is currently a serving member
on various Lloyd's committees including the Lloyd's Corporate Capital
Association and Lloyd's Market Board.
Charles F. Hays serves as Senior Vice President, Chief Financial &
Administrative Officer of the Company, is a director of Holdings, and Executive
Vice President, Chief Financial & Administrative Officer of Mid Ocean
Reinsurance. He also serves as a director of Harris & Harris Group. Mr. Hays
served as Managing Director and Chief Financial Officer of Marsh & McLennan
Incorporated from 1984 to 1993.
Henry C. V. Keeling, is a director of Holdings and serves as President, Chief
Operating & Underwriting Officer of Mid Ocean Reinsurance. Mr Keeling served as
a director of Taylor Clayton (Underwriting Agencies) Ltd. and deputy underwriter
for syndicate 51 at Lloyd's from 1984 through 1992.
PART II
ITEM 5 - MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The Company's Class A Ordinary Shares, $0.20 par value, have been included for
trading on The New York Stock Exchange, Inc since May 30, 1996, under the symbol
"MOC" and, before that, on The Nasdaq National Market since August 4, 1993,
under the symbol "MOCNF".
The following table sets forth the high and low closing sales prices per share
of the Company's Class A Ordinary Shares for each fiscal quarter period from
November 1, 1995 to October 31, 1997.
<TABLE>
<CAPTION>
High Low
---- ---
<S> <C> <C>
1996
First Quarter $41.625 $35.563
Second Quarter 42.000 35.625
Third Quarter 42.625 35.500
Fourth Quarter 48.125 39.625
</TABLE>
<PAGE> 17
15
<TABLE>
<CAPTION>
High Low
---- ---
<S> <C> <C>
1997
First Quarter $53.750 $47.000
Second Quarter 51.125 45.250
Third Quarter 60.500 44.500
Fourth Quarter 64.875 56.437
</TABLE>
As of January 12, 1998, there were approximately 17,000 holders of Class A
Ordinary Shares.
DIVIDENDS
The following table sets forth for the fiscal quarters of the two most recent
fiscal years all dividends declared during such period:
<TABLE>
<CAPTION>
Dividends
per share
<S> <C>
1996 First Quarter $ 0.25
Second Quarter $ 0.275
Third Quarter $0.4125
Fourth Quarter $0.4125
1997 First Quarter $ 0.75
Second Quarter $ 0.75
Third Quarter $ 0.75
Fourth Quarter $ 0.75
</TABLE>
The Company declared a dividend per Ordinary Share of $0.25 on December 7, 1995,
$0.275 on February 29, 1996, $0.4125 on June 18, 1996 and September 13, 1996.
The Company declared a dividend of $ 0.75 on December 5, 1996, March 6, 1997,
June 5, 1997,and September 11, 1997. On December 4,1997 the dividend declared by
the Company was increased to $0.825.
The Company is a holding company whose principal source of income is dividends
from its operating subsidiaries. The ability of the operating subsidiaries to
pay dividends to the Company and the Company's ability to pay dividends to its
shareholders are each subject to legal and regulatory restrictions. Future
payment of dividends will be at the discretion of the Board of Directors and
will be dependent upon the profits and financial requirements of the Company and
other factors, including legal restrictions on the payment of dividends and such
other factors as the Board of Directors deems relevant.
Neither the Cayman Islands, where the Company is incorporated, nor Bermuda,
where its executive offices are located, presently imposes any income or
withholding taxes upon dividends by the Company to non-resident shareholders, or
presently imposes any exchange control that would affect dividends or other
payments to non-resident holders of Ordinary Shares.
RESTRICTIONS ON VOTING AND TRANSFER
The Articles of Association of the Company contain various provisions affecting
the transferability of Ordinary Shares. Under the Articles of Association, the
Board of Directors may decline to register any transfer of Ordinary Shares if
the Board of Directors determines that such transfer would result in a United
States Person having Controlled Shares that constitute more than 9.9% of the
voting power of the Ordinary Shares. The Articles of Association also provide
that the Board of Directors may decline to register the transfer of Ordinary
Shares that have not been sold pursuant to an effective registration statement
under the Securities Act or pursuant to Rule 144 thereunder. A transferee will
be permitted to dispose of any Ordinary Shares purchased which violate the
restrictions and as to the transfer of which registration is refused. The
transferor of such Ordinary Shares will be deemed to own such Ordinary Shares
for dividend, voting and reporting purposes until a transfer of such Ordinary
Shares has been
<PAGE> 18
16
registered on the stock transfer records of the Company. If and so long as the
Controlled Shares (as defined below) of any United States Person (as defined
below) constitute 10% or more of the voting power of the issued Ordinary Shares,
the voting rights with respect to the Controlled Shares owned by such person
shall be limited, pursuant to a formula specified in the Articles of
Association, in the aggregate, to less than 10%. "Controlled Shares" shall
include among other things, all Ordinary Shares which such person is deemed to
beneficially own directly, indirectly or constructively (within the meaning of
Section 13(d) of the Securities Internal Review Code of 1986, as amended, (the
"Code"). "United States Person" means a United States person as defined in
Section 7701 (a) (3) of the Code.
ITEM 6 - SELECTED FINANCIAL DATA
This item is incorporated by reference to the Selected Financial Data table
contained in the 1997 Annual Report.
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
This item is incorporated by reference to Management's Discussion and Analysis
of Results of Operations and Financial Condition in the 1997 Annual Report.
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
This item is incorporated by reference to the financial statements in the 1997
Annual Report.
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 three years ending October 31,
1997.
PART III
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
This item is omitted because a definitive proxy statement which involved 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.
ITEM 11 - EXECUTIVE COMPENSATION
This item is omitted because a definitive proxy statement which involved 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.
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
This item is omitted because a definitive proxy statement which involved 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.
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
This item is omitted because a definitive proxy statement which involved 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.
<PAGE> 19
17
PART IV
ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(A) FINANCIAL STATEMENTS AND EXHIBITS
1. Consolidated Financial Statements
The following Consolidated Financial Statements of Mid Ocean Limited
and Report of Independent Auditors are incorporated by reference to
pages 28 through 51 of the registrant's 1997 Annual Report to
Shareholders:
Independent Auditors' Report
Consolidated Balance Sheets - October 31, 1997 and 1996
Consolidated Statements of Operations - Years ended October 31, 1997,
1996 & 1995
Consolidated Statements of Shareholders' Equity - Years
ended October 31, 1997, 1996 & 1995
Consolidated Statements of Cash
Flows - Years ended October 31, 1997, 1996 & 1995
Notes to Consolidated Financial Statements
2. Financial Statement Schedules
Schedule I Consolidated Summary of Investments
III Supplementary Insurance Information
IV Reinsurance
Other Schedules have been omitted as they are not applicable to the
Company.
3. Exhibits
3.1 - Memorandum of Association of the Company (incorporated by
reference from the Company's Registration Statement on Form S-1
(File No. 33-63298) (the "Registration Statement").
3.2 - Articles of Association of the Company (incorporated by reference
from the Registration Statement).
4.1 - Rights Agreement, dated September 12, 1996, between Mid Ocean
Limited and the Bank of New York, as Rights Agent (incorporated by
reference from the Company's Report on Form 8-K filed September
12, 1996).
10.01 - 1993 Long-Term Incentive and Share Award Plan (incorporated by
reference from the Registration Statement).
10.02 - Letter of Credit Facility and Security Agreement (incorporated by
reference from the Registration Statement).
10.03 - Investment Management Agreement, dated as of November 1, 1993
between Brinson Partners Inc and Mid Ocean (incorporated by
reference to the Company's Form 10-K for the year ended October
31, 1993)
10.04 - Investment Management Agreement, dated as of November 1, 1993
between Warburg Asset Management and Mid Ocean Reinsurance
(incorporated by reference to the Company's Form 10-K for the year
ended October 31, 1993).
10.05 - Employment Agreement (amended and restated as of August 19, 1996)
between Michael A. Butt and Mid Ocean Reinsurance Company Ltd. and
Mid Ocean Limited (incorporated by reference to the Company's Form
10-K for the year ended October 31, 1996).
<PAGE> 20
18
10.06 - Service Agreement (amended and restated as of August 19, 1996)
between Robert J. Newhouse Jr. and Mid Ocean Reinsurance Company
Ltd. and Mid Ocean Limited (incorporated by reference to the
Company's Form 10-K for the year ended October 31, 1996).
10.07 - Employment Agreement (amended and restated as of August 19, 1996)
between Henry C. V. Keeling and Mid Ocean Reinsurance Company Ltd.
(incorporated by reference to the Company's Form 10-K for the year
ended October 31, 1996).
10.08 - Employment Agreement (amended and restated as of August 19, 1996)
between Charles F. Hays and Mid Ocean Reinsurance Company Ltd. and
Mid Ocean Limited (incorporated by reference to the Company's Form
10-K for the year ended October 31, 1996).
11.1 - Statement of Computation of Earnings Per Share for the fiscal
years ended October 31, 1997, 1996 and 1995.
13.1 - Pages 14 - 51 of the Mid Ocean Limited 1997 Annual Report to
Shareholders.
21.1 - List of subsidiaries of the Registrant.
23.1 - Consent of KPMG Peat Marwick.
24.1 - Powers of Attorney
27.1 - Financial Data Schedule (incorporated herein by reference to the
Company's Form 10-K for the year ended October 31, 1997).
99-1 - Extracts from the Company's Registration statement on Form S-1
(file No. 33-63298) concerning taxation of the Company and Mid
Ocean.
(B) REPORTS ON FORM 8-K
No reports on form 8-K were filed by the Company in the quarter ended October
31, 1997.
<PAGE> 21
19
AUDITOR'S REPORT ON FINANCIAL STATEMENT
SCHEDULES INCLUDED IN FORM 10-K
The Board of Directors and Shareholders
Mid Ocean Limited
Under date of November 21, 1997, we reported on the consolidated balance sheets
of Mid Ocean Limited and subsidiaries as of October 31, 1997 and 1996, and the
related consolidated statements of operation, shareholders' equity and cash
flows for each of the years in the three year period ended October 31, 1997, as
contained in the 1997 Annual Report to Shareholders. These consolidated
financial statements and our report thereon are incorporated by reference in the
annual report on Form 10-K for the year 1997. In connection with our audit of
the aforementioned consolidated financial statements, we also have audited the
related consolidated financial statement schedules as listed in Part IV on page
16. These financial statement schedules are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statement schedules based on our audit.
In our opinion, such financial statement schedules, when considered in relation
to the basic financial statements taken as whole, present fairly, in all
material respects, the information set forth therein.
KPMG PEAT MARWICK
Hamilton, Bermuda
November 21, 1997
<PAGE> 22
20
SUPPLEMENTAL SCHEDULE I
CONSOLIDATED SUMMARY OF INVESTMENTS
OCTOBER 31, 1997
(US DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
COST OR AMOUNT AT WHICH
AMORTIZED FAIR SHOWN IN THE
COST(1) VALUE BALANCE SHEET
-------- -------- --------
<S> <C> <C> <C>
TYPE OF INVESTMENT
Fixed Maturities:
US government and government agencies
and authorities $ 305.1 $ 308.2 $ 308.2
Taxable municipal bonds 22.5 23.1 23.1
Corporate Bonds 447.1 452.8 452.8
Non-US sovereign governments 248.7 251.7 251.7
Asset-backed securities 427.6 431.6 431.6
Mortgage-backed securities 33.4 34.8 34.8
-------- -------- --------
Total fixed maturities 1,484.4 1,502.2 1,502.2
Short-term investments 21.1 21.1 21.1
Equity securities:
Industrial, miscellaneous and all other 22.4 23.5 23.5
-------- -------- --------
Total Investments $1,527.9 $1,546.8 $1,546.8
======== ======== ========
</TABLE>
(1) Investments in fixed maturities and short-term investments are shown at
amortized cost.
<PAGE> 23
21
SCHEDULE III
MID OCEAN LIMITED
SUPPLEMENTARY INSURANCE INFORMATION
OCTOBER 31, 1997, 1996 AND 1995
(US DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
Losses, Amortization
Deferred Claims and Net Losses and of Deferred
Acquisition Claim Unearned Premium Investment Settlement Acquisition
Year Ended Costs Expenses Premiums Revenue Income Expenses Costs
<S> <C> <C> <C> <C> <C> <C> <C>
October 31, 1997
Property and Liability Insurance $ 45.9 $497.0 $321.8 $486.7 $103.4 $216.2 $ 85.9
October 31, 1996
Property and Liability Insurance $ 42.6 $427.7 $303.3 $436.1 $ 83.3 $211.9 $ 70.1
October 31, 1995
Property and Liability Insurance $ 22.8 $336.1 $206.3 $379.4 $ 73.8 $198.6 $ 53.4
<CAPTION>
Other
Operating Premiums
Year Ended Expenses Written
<S> <C> <C>
October 31, 1997
Property and Liability Insurance $ 54.0 $505.5
October 31, 1996
Property and Liability Insurance $ 34.4 $525.7
October 31, 1995
Property and Liability Insurance $ 17.3 $435.0
</TABLE>
<PAGE> 24
22
SCHEDULE IV
MID OCEAN LIMITED
REINSURANCE
OCTOBER 31, 1997, 1996 AND 1995
(US DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
PERCENTAGE
CEDED TO ASSUMED OF AMOUNT
GROSS OTHER FROM OTHER NET ASSUMED
YEAR ENDED AMOUNT COMPANIES COMPANIES AMOUNT TO NET
- ---------- ------ --------- --------- ------ ------
<S> <C> <C> <C> <C> <C>
October 31, 1997
Property and Liability Insurance $ 83.2 $ 56.7 $460.2 $486.7 94.5%
October 31, 1996
Property and Liability Insurance $ 36.3 $ 29.9 $429.7 $436.1 98.5%
October 31, 1995
Property and Liability Insurance $ -- $ 10.2 $389.6 $379.4 102.7%
</TABLE>
<PAGE> 25
23
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 the registration
statement to be signed on its behalf by the undersigned, thereunto duly
authorized.
MID OCEAN LIMITED
By: /s/ Charles Hays
-----------------------
Charles F. Hays
Senior Vice President, Chief Financial
& Administrative Officer (Principal
Financial and Accounting Officer)
June 26, 1998
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons in the capacities and on the
dates indicated.
<TABLE>
<CAPTION>
Signatures Title Date
---------- ----- ----
<S> <C> <C>
*
- -----------------------
Robert J. Newhouse, Jr. Chairman of the Board June 26 , 1998
/s/ Michael Butt
- -----------------------
Michael A. Butt President & Chief Executive Officer June 26, 1998
(Principal Executive Officer)
*
- -----------------------
Frank J. Borelli Director June 26, 1998
*
- -----------------------
Sir Brian Corby Director June 26, 1998
*
- -----------------------
Geoffrey Elliott Director June 26, 1998
*
- -----------------------
Michael P. Esposito, Jr. Director June 26, 1998
*
- -----------------------
Robert R. Glauber Director June 26, 1998
</TABLE>
<PAGE> 26
24
<TABLE>
<S> <C> <C>
*
- -----------------------
Henry U. Harder Director June 26, 1998
*
- -----------------------
Paul Jeanbart Director June 26, 1998
*
- -----------------------
Roberto Mendoza Director June 26, 1998
*
- -----------------------
Brian O'Hara Director June 26, 1998
*
- -----------------------
John Pasquesi Director June 26, 1998
*
- -----------------------
Henry H. Peters Director June 26, 1998
*
- -----------------------
Jeffrey S. Tabak Director June 26, 1998
*
- -----------------------
Frank J. Tasco Director June 26, 1998
</TABLE>
*By: /s/ Charles Hays
-------------------
Charles F. Hays
Attorney in Fact
<PAGE> 1
Exhibit 11.1
MID OCEAN LIMITED
STATEMENT OF COMPUTATION OF EARNINGS PER SHARE
YEARS ENDED OCTOBER 31, 1997, 1996 AND 1995
(EXPRESSED IN THOUSANDS OF UNITED STATES DOLLARS
EXCEPT FOR NUMBER OF SHARES AND EARNINGS PER SHARE)
<TABLE>
<CAPTION>
1997 1996 1995
-------------------------------------------------------------------------------------------
Primary Fully Primary Fully Primary Fully
Diluted Diluted Diluted
-------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Net Income $ 245,008 $ 245,008 $ 211,644 $ 211,644 $ 182,935 $ 182,935
Number of Shares
Weighted average
shares outstanding 37,596,430 37,596,430 34,453,134 34,453,134 35,657,570 35,657,570
Incremental shares of
outstanding options (1) 330,533 353,782 434,588 451,297 271,243 318,597
Incremental shares
of outstanding stock options
of Mid Ocean Reinsurance (2) -- -- 1,951,235 1,997,912 1,417,690 1,555,992
----------- ----------- ----------- ----------- ----------- -----------
37,926,963 37,950,212 36,838,957 36,902,343 37,346,503 37,532,159
----------- ----------- ----------- ----------- ----------- -----------
Earnings per share: $ 6.46 $ 6.46 $ 5.75 $ 5.74 $ 4.90 $ 4.87
----------- ----------- ----------- ----------- ----------- -----------
</TABLE>
(1) As of October 31, 1997, the Company has 745,368 (1996: 903,454; 1995:
947,838) options outstanding. The dilution on a primary basis would be the
equivalent of approximately 330,533 (1996: 434,588; 1995: 271,243) shares, using
the treasury stock method, based on the average market price.
(2) As of October 31, 1997, Mid Ocean Reinsurance has nil (1996: 560,645; 1995:
560,645) options outstanding. Each holder of Mid Ocean Reinsurance options
entered into a put/call agreement which entitled it to put the shares of Mid
Ocean Reinsurance issued upon the exercise of its options to the Company in
exchange for, at the election of the Company, shares of the Company having a
fair market value or an amount of cash equal to the fair market value of the Mid
Ocean Reinsurance shares so put. These options were exercised during the year
ended October 31, 1997. Such agreements permitted the Company to call any Mid
Ocean Reinsurance shares so issued in exchange for shares of the Company having
a fair market value equal to the fair market value of the Mid Ocean Reinsurance
shares so called. Dilution on a primary basis would be the equivalent of nil
(1996: 1,951,235; 1995: 1,417,690) shares using the treasury stock method, based
on the receipt of six shares of the Company for each share of Mid Ocean
Reinsurance common stock issued upon the exercise of the options and the average
market price for the year.
<PAGE> 1
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL
CONDITION
General
Mid Ocean Limited ("the Company") is the parent company of Mid Ocean Holdings
Limited ("Holdings") which has two wholly-owned subsidiaries; Mid Ocean
Reinsurance Company Ltd. ("Mid Ocean Reinsurance") and Ridgewood Holdings Ltd.
("Ridgewood"). Ridgewood is the Bermuda holding company of The Brockbank Group
plc ("Brockbank"). Brockbank includes two dedicated corporate syndicates
("corporate syndicates") and a managing agency. The Company, through its
subsidiaries, provides a broad range of reinsurance and insurance products on a
global basis.
Mid Ocean Reinsurance, based in Bermuda with branch operations in London
and Singapore and an office in Munich, is a leading reinsurer writing property
catastrophe, property excess of loss, property pro rata, marine and energy,
aviation and satellite and various other risks. Mid Ocean Reinsurance assumes
risks which are diversified both geographically and across ceding companies and
which generally have aggregate limits and varying attachment points. Property
catastrophe gross written premiums represented approximately 46% of Mid Ocean
Reinsurance's total gross written premiums in 1997. Property catastrophe loss
experience is generally characterized as low frequency but high severity in
nature and may result in volatility in the Company's financial results for any
fiscal quarter or year.
Mid Ocean Reinsurance's London branch writes marine and energy, and
aviation excess of loss reinsurance. Its Singapore branch writes property,
treaty and facultative, and a small amount of casualty business. A consulting
office in Munich was established in 1996.
Brockbank is a leading Lloyd's managing agency which provides underwriting
and other services to five Lloyd's syndicates, two of which are dedicated
corporate syndicates whose capital is provided solely 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
1997 [LOGO] MID OCEAN LIMITED ANNUAL REPORT
<PAGE> 2
group of clients. In December 1995, Mid Ocean Reinsurance acquired a 51%
interest in Brockbank and in August 1997 the Company completed the acquisition
of the remaining 49% interest. Total underwriting capacity managed by Brockbank
was $840.0 million in 1997. Of this amount, dedicated capacity was $230.6
million or 27%. The Company increased its dedicated capacity to $339.7 million
for the 1998 year of account which will represent an estimated 38% of the total
capacity to be managed by Brockbank for the 1998 year of account.
The Company's fiscal year end is October 31. References to 1997, 1996 and
1995 refer to the fiscal years ended October 31, 1997, 1996 and 1995,
respectively. Brockbank's fiscal year end is December 31. Results of operations
relating to Brockbank for the nine month period from January 1, 1996, (the date
of acquisition of a 51% interest) to September 30, 1996 are included in the
Company's fiscal year end October 31, 1996 whereas results of Brockbank's
operations for the twelve month period ended September 30, 1997 are included in
the Company's fiscal year end October 31, 1997.
The following is a discussion of the Company's results of operations and
financial condition. This discussion and analysis should be read in conjunction
with the audited Consolidated Financial Statements and related notes of the
Company presented on pages 27 through 50 of this annual report. The results of
operations for any fiscal period are not necessarily indicative of future
financial results.
<TABLE>
<CAPTION>
RESULTS OF OPERATIONS 1997 % Change 1996 % Change 1995
($ millions)
<S> <C> <C> <C> <C> <C>
Net operating income
(excluding net gain on investments) $ 235.4 12.4% $ 209.5 15.5% $ 181.4
Net gain on investments 9.6 357.1 2.1 40.0 1.5
Net income $ 245.0 15.8% $ 211.6 15.7% $ 182.9
</TABLE>
Net income for 1997 increased 15.8% over 1996 which had increased 15.7%
over 1995. All three years financial results benefited from low loss activity
and progressively
MANAGEMENT'S DISCUSSION AND ANALYSIS
15
<PAGE> 3
larger releases of loss reserves established in prior years. 1997 also benefited
from cyclically high profit commissions from the Brockbank managing agency
activities.
PREMIUMS
<TABLE>
<CAPTION>
NET PREMIUMS WRITTEN 1997 % CHANGE 1996 % CHANGE 1995
($ millions)
<S> <C> <C> <C> <C> <C>
Property catastrophe $146.1 (10.1)% $162.5 (20.5)% $204.4
Property other 93.4 (29.1) 131.8 3.8 127.0
Marine and energy 40.7 (23.6) 53.3 (10.1) 59.3
Aviation and satellite 37.6 (1.6) 38.2 17.2 32.6
Corporate syndicates 181.3 44.3 125.6 N/A --
Other 6.4 (55.2) 14.3 22.2 11.7
------ ----- ------ ----- ------
Total $505.5 (3.8)% $525.7 20.9% $435.0
------ ----- ------ ----- ------
</TABLE>
<TABLE>
<CAPTION>
NET PREMIUMS EARNED 1997 % CHANGE 1996 % CHANGE 1995
($ millions)
<S> <C> <C> <C> <C> <C>
Property catastrophe $143.6 (16.8)% $172.6 (10.6)% $193.1
Property other 99.5 (22.6) 128.6 53.5 83.8
Marine and energy 49.2 (9.2) 54.2 (19.2) 67.1
Aviation and satellite 34.6 17.7 29.4 42.7 20.6
Corporate syndicates 147.4 259.5 41.0 N/A --
Other 12.4 20.4 10.3 (30.5) 14.8
------ ----- ------ ----- ------
Total $486.7 11.6% $436.1 15.0% $379.4
------ ----- ------ ----- ------
</TABLE>
Net premiums written decreased $20.2 million or 3.8% in 1997 compared to
1996. This decline is due to a reduction of $75.9 million of net written
premiums by Mid Ocean Reinsurance which is offset by an increase of $55.7
million relating to the corporate syndicates.
The decrease in net premiums written by Mid Ocean Reinsurance was due to a
general decline in premium rates across most classes of business in a continued
competitive pricing environment; a decision to write less premiums in certain
business
1997 [LOGO] MID OCEAN LIMITED ANNUAL REPORT
<PAGE> 4
where pricing levels were not considered adequate to support the risk; and
approximately $24.4 million of negative adjustments relating to premium
estimates on contracts recorded in prior years. In particular, property
catastrophe premium rates measured on an exposure adjusted basis, were down
approximately 12% on major United States risks. The United Kingdom, Japanese and
Australian markets saw rates decline between approximately 15% to 20%. The other
classes of business Mid Ocean Reinsurance writes were also affected by lower
rates than in the prior year. This is due to the fact that the reinsurance
industry, in general, has excess capacity and certain companies seem willing to
write coverage at reduced rates to protect their book of business. Mid Ocean
Reinsurance expects that the reinsurance industry will face similar price
pressures in the premium rate environment in 1998 as experienced in 1997.
The increase in net premiums written by the corporate syndicates is due to
the fact that twelve months results are included in 1997 compared to nine months
in 1996. In addition there was a 40% increase in the underwriting capacity of
these syndicates for the 1997 underwriting year as compared to the 1996
underwriting year.
Premiums ceded in 1997 were $55.0 million compared with $40.6 million in
1996, an increase of $14.4 million. The majority of this increase is
attributable to the corporate syndicates which purchase more reinsurance than
Mid Ocean Reinsurance.
Net premiums earned during 1997 increased $50.6 million, or 11.6% over
1996. This increase results from a $106.4 million increase relating to the
corporate syndicates, offset by a decrease for Mid Ocean Reinsurance of $55.8
million. The increase in net premiums earned for the corporate syndicates is due
to the increased level of net premiums written by the syndicates, the inclusion
of twelve months results in 1997 as opposed to nine months in 1996, and the fact
that net premiums are being earned in respect of two underwriting years in
fiscal 1997, whereas in fiscal 1996 they were earned for one. Net premiums
earned decreased for Mid Ocean Reinsurance due to the reduction in net premiums
written. Premiums written are earned over the underlying risk period of each
contract, commencing at the inception of the contract.
Net premiums written for 1996 were $525.7 million, or 20.9% above 1995.
This growth was attributable to the results of the corporate syndicates which
were included in the
MANAGEMENT'S DISCUSSION AND ANALYSIS
17
<PAGE> 5
Company's accounts for the first time following the acquisition of a 51%
interest in Brockbank on December 29, 1995. Net premiums written attributable to
the corporate syndicates amounted to $125.6 million while another syndicate,
managed by Brockbank and reinsured by Mid Ocean Reinsurance, decreased by $18.3
million. In the aggregate, net premiums written on Mid Ocean Reinsurance's
remaining book of business were flat. However, the property catastrophe book
decreased by $41.9 million and the marine and energy book decreased by $6.0
million compared with 1995. These decreases were offset by increases in aviation
and satellite and other lines.
During 1996, compared to 1995, property catastrophe premium rates
applicable to Mid Ocean Reinsurance's book of business, measured on an exposure
adjusted basis, were down approximately 6% on major United States risks.
Measured on the same basis, the United Kingdom, Japanese and Australian markets
experienced rate declines of approximately 11%, 16% and 7%, respectively.
Premiums ceded in 1996 were $40.6 million compared with $10.8 million in
1995, an increase of $29.8 million. Approximately $21.9 million of this increase
is attributable to the corporate syndicates. In addition, Mid Ocean Reinsurance
purchased specific reinsurance protection at a cost of approximately $13.3
million. The reinsurance was purchased to protect various aspects of Mid Ocean
Reinsurance's book of business in response to a greater availability of these
covers at more attractive prices.
Net premiums earned during 1996 increased $56.7 million or 15.0% over 1995.
The increase is primarily attributable to the increased level of net premiums
written.
<TABLE>
<CAPTION>
INVESTMENT RESULTS 1997 % Change 1996 % Change 1995
($ millions)
<S> <C> <C> <C> <C> <C>
Net investment income $ 103.4 24.1% $ 83.3 12.9% $ 73.8
Net gains on investments $ 9.6 357.1% $ 2.1 40.0% $ 1.5
</TABLE>
The increases in net investment income resulted from the continued growth
of the investment base and from the relatively higher returns provided by modest
1997 [LOGO] MID OCEAN LIMITED ANNUAL REPORT
<PAGE> 6
substitutions of investment grade and high yield securities for U.S. Treasuries.
The investment portfolio, measured on a market value basis, yielded 6.5% in
1997, compared with 6.2% in 1996 and 6.4% in 1995.
The Company carries its investment portfolio at fair value and has
classified it as "available for sale". As a result, the net unrealized market
appreciation or depreciation attributable to securities held in the portfolio is
included as a separate component of shareholders' equity. At October 31, 1997,
shareholders' equity included unrealized appreciation of $18.7 million compared
with $6.9 million at October 31, 1996 and $13.8 million at October 31, 1995.
This was the result of fluctuations in interest rates. Total returns on
investments, measured on a market value basis, were 8.2% for 1997 compared with
5.9% for 1996 and 12.4% for 1995.
<TABLE>
<CAPTION>
OTHER REVENUE 1997 % Change 1996 % Change 1995
($ millions)
<S> <C> <C> <C> <C> <C>
Exchange loss $ (10.0) 525.0% $ (1.6) (33.3%) $(2.4)
Managing agency income $ 20.9 45.1% $ 14.4 N/A $ --
Other income $ 8.7 81.3% $ 4.8 N/A $ --
</TABLE>
The exchange loss in 1997 relates mainly to the British pound exchange rate
movements in the year. The majority of Mid Ocean Reinsurance's British pound
denominated premiums written were recorded on January 1, at a higher exchange
rate than the rate at the balance sheet date at which related receivables were
revalued.
Managing agency income relates to fees earned by the managing agency in
respect of its management of Lloyd's syndicates and earned profit commissions
which are estimated based on anticipated results of the syndicates it manages.
Managing agency income attributable to the corporate syndicates is eliminated on
consolidation. Profit commissions are settled to the managing agency after an
underwriting year has been closed, which is three years after inception. During
1997 there was an increase in the estimated profit commission to be earned by
the managing agency relating to the 1995 underwriting year of the syndicates of
$7.2 million. In addition, 1997 included twelve months of results, compared to
nine months in 1996.
MANAGEMENT'S DISCUSSION AND ANALYSIS
19
<PAGE> 7
Other income relates to fee income from other insurance related services of
Brockbank. The increase in other income for 1997 over 1996 is due to the
inclusion of twelve months results in 1997, as opposed to nine months in 1996
and the increased capacity provided to one of the corporate syndicates.
<TABLE>
<CAPTION>
EXPENSES 1997 1996 1995
<S> <C> <C> <C>
Net loss and loss expense ratio 44.4% 48.6% 52.4%
Underwriting expense ratio 28.7% 24.0% 18.6%
Combined ratio 73.1% 72.6% 71.0%
</TABLE>
The combined ratio is computed based on the relationship of net losses and
underwriting expenses to net earned premiums. The combined ratio is a principal
indicator of underwriting performance, with less than 100% indicating an
underwriting profit.
<TABLE>
<CAPTION>
LOSS AND LOSS EXPENSES 1997 1996 1995
($ millions)
<S> <C> <C> <C>
Loss and loss expenses $ 242.3 $ 216.5 $ 200.1
Reinsurance recoveries 26.1 4.6 1.4
Net loss and loss expenses $ 216.2 $ 211.9 $ 198.7
Net loss and loss expense ratio 44.4% 48.6% 52.4%
</TABLE>
During 1997, the Company's net loss and loss expenses increased $4.3
million. The increase in reinsurance recoveries is due to the corporate
syndicates which purchase more reinsurance than Mid Ocean Reinsurance. There
were no significant catastrophic events during 1997 or 1996. This factor,
together with a larger release of loss reserves established in prior years, has
contributed to a lower loss ratio for Mid Ocean Reinsurance during 1997, as
compared to 1996. Approximately 46% of Mid Ocean Reinsurance's gross written
premium is property catastrophe, where loss experience is generally
characterized as low frequency but high severity. Business written by the
corporate syndicates in contrast, has loss experience which is higher in
frequency but lower in severity than Mid Ocean Reinsurance. Accordingly, where
there is an absence of major catastrophic loss events, loss ratios on business
written by the corporate syndicates will be higher than for Mid Ocean
Reinsurance and this has been the case during 1997 and 1996.
This reduction is offset by higher incurred loss ratios relating to the
business written by the corporate syndicates which were applied to net earned
premiums which increased during 1997 over 1996 by $106.4 million. There has
been no change in the classes of business written by the corporate syndicates
in 1997 over 1996 but there has been significant increase in the amount of net
premiuns written and earned by the corporate syndicates in 1997 over 1996.
1997 [LOGO] MID OCEAN LIMITED ANNUAL REPORT
<PAGE> 8
The Company's 1996 incurred net loss and loss expenses increased $13.2
million over 1995. Mid Ocean Reinsurance maintains loss reserves for a specific
aviation loss of $7.5 million established during the year ended October 31,
1996. The larger catastrophe provisions established during the year ended
October 31, 1995, were a $5.0 million provision in respect of the 1995 Great
Hanshin, Kobe earthquake and a $21.5 million provision in respect of Hurricanes
Luis and Marilyn.
Net loss reserves amounted to $479.2 million, $422.3 million and $329.0
million at October 31, 1997, 1996 and 1995, respectively. Included in these
amounts are loss and loss expenses for losses incurred but not reported ("IBNR")
of $351.0 million, $318.0 million and $258.0 million respectively. The Company
paid losses during 1997 of $159.3 million, compared to $118.6 million in 1996
and $84.7 million in 1995. The majority of the increase in 1997 paid losses over
1996 is due to the inclusion of the corporate syndicates for twelve months,
compared to nine months in 1996 and losses in respect of two underwriting years,
compared to one in 1996. In 1997 paid losses did not include any significant
individual losses. In 1996 paid losses included $11.3 million with respect to
the 1994 Northridge, California earthquake ("Northridge"), $13.4 million for
Hurricanes Luis and Marilyn and $11.2 million for three risk excess losses. In
1995 paid losses included $26.5 million for Northridge and $8.5 million for a
single risk excess loss.
In determining that portion of loss and loss expenses for IBNR for a year,
management classifies business written by the Company into segments that could
reasonably be expected to have similar loss characteristics. Reporting patterns
and initial expected loss ratios are developed based upon Company and industry
data, knowledge of the business written by the Company and general market trends
in the reinsurance and insurance industry. Mid Ocean Reinsurance's loss
experience to date has been more favorable than originally assumed, which has
led to the releases of loss reserves established in prior years.
Reinsurance purchased by the corporate syndicates is at much lower
attachment points and in relatively larger amounts than that purchased by Mid
Ocean Reinsurance. The reinsurance purchased is placed with different brokers
and with many different reinsurers. As net premiums written and earned by the
corporate syndicates increase, as has been the case in 1997 over 1996, the
gross losses incurred on that business also increase. An increase in gross
losses incurred will in turn increase the amount of reinsurance recoveries
recorded.
MANAGEMENT'S DISCUSSION AND ANALYSIS
21
<PAGE> 9
UNDERWRITING EXPENSES
<TABLE>
<CAPTION>
ACQUISITION EXPENSES AND RATIOS 1997 1996 1995
($ millions)
<S> <C> <C> <C>
Acquisition expense $ 85.9 $ 70.1 $ 53.4
Acquisition expense ratio 17.6% 16.1% 14.1%
</TABLE>
The $15.8 million increase in acquisition expenses in 1997 over 1996 was
due to the inclusion of higher acquisition expenses related to an increased
amount of net premiums earned by the corporate syndicates during 1997 as well as
the inclusion of twelve months of Brockbank's results versus nine months in
1996. The $16.7 million increase in acquisition expenses in 1996 over 1995 was
due to the inclusion of the results of the corporate syndicates for nine months
of 1996.
The increase in the acquisition expense ratio from year to year is
primarily attributable to the higher profit commissions payable to cedents by
Mid Ocean Reinsurance. As Mid Ocean Reinsurance's pro-rata business has
developed over time, profitability has increased relative to the original
estimates, with a resulting increase in profit commissions paid or accrued to
cedents.
<TABLE>
<CAPTION>
OPERATIONAL EXPENSES AND RATIOS 1997 1996 1995
($ millions)
<S> <C> <C> <C>
Operational expenses $ 54.0 $ 34.4 $ 16.7
Operational expense ratio 11.1% 7.9% 4.5%
</TABLE>
The $19.6 million increase in operational expenses in 1997 over 1996 was
due to the inclusion of twelve months of results for Brockbank versus nine
months in 1996 (which accounted for $11.2 million of the increase) as well as
the continued growth of Mid Ocean Reinsurance's operations. Of the $17.7
million, or 106% increase in operational expenses in 1996 over 1995, $14.0
million was due to the inclusion of the corporate syndicates' operational
expenses for nine months of 1996. The remainder was attributable to the growth
of Mid Ocean Reinsurance's operations.
1997 [LOGO] MID OCEAN LIMITED ANNUAL REPORT
<PAGE> 10
The increase in the operational expenses ratio is the result of Mid Ocean
Reinsurance's operational expenses increasing, as compared to a lower amount of
net earned premiums year over year.
<TABLE>
<CAPTION>
OTHER EXPENSES 1997 % Change 1996 % Change 1995
($ millions)
<S> <C> <C> <C> <C>
Managing agency expenses $ 4.9 (2.0)% $ 5.0 -- $ --
Income taxes $ 11.8 162.2% $ 4.5 -- $ --
</TABLE>
Managing agency expenses are the cost of operating the Brockbank managing
agency not allocable to the syndicates it manages. These costs are associated
with managing agency income noted above in the discussion of revenues and are
not included in the determination of the Company's expense ratio.
Income taxes represent estimated income taxes in the United Kingdom for
Brockbank and the London branch. The increase in 1997, as compared to 1996, was
due to the increased profits of the London branch and inclusion of Brockbank's
results for twelve months in 1997, compared to nine months in 1996.
Financial Condition and Liquidity
The Company's assets consist of its investment in the stock of Holdings, which
is the parent company of Mid Ocean Reinsurance and Brockbank. The Company relies
primarily on cash dividends from Holdings, which relies on dividends from its
direct and indirect subsidiaries. The payment of such dividends is restricted by
applicable law under Bermuda and United Kingdom insurance law and regulations,
including those promulgated by the Society of Lloyd's. Currently there are no
effective statutory restrictions on the payment of dividends by the Company or
its subsidiaries. On December 4, 1997 the Board of Directors approved an
increase in annualized dividends to $3.30. During 1997, annualized dividends
declared by the Company were increased to $3.00 from $1.35 in 1996. The payment
of the dividend in any quarter is at the discretion of the Board of Directors of
the Company.
At October 31, 1997, shareholders' equity was $1,373.0 million, of which
$610.8 million was retained earnings.
MANAGEMENT'S DISCUSSION AND ANALYSIS
23
<PAGE> 11
At October 31, 1997, the Company held $122.8 million of cash and cash
equivalents, compared with $164.0 million at October 31, 1996. The decrease is
attributable in part to the completion of the acquisition of the remaining 49%
of Brockbank and the increased level of dividends during 1997.
The Company's consolidated sources of funds consist primarily of net
premiums written, investment income and the proceeds from sales and maturities
of investments. Funds are used primarily to pay claims, operating expenses and
dividends and for the purchase of investments. Net cash flow provided by
operating activities was $283.0 million in 1997, as compared with $330.6 million
in 1996. The Company expects cash inflows will continue to be strong, primarily
from reinsurance and insurance premium receipts and investment income. The
Company is unable to predict its cash outflows as they will be substantially
determined by loss payments and particularly large catastrophes if they occur.
As a consequence, cash flow may fluctuate between individual fiscal quarters and
years.
Primarily due to the potential for large loss payments, the Company's
investment portfolio is structured to provide a high level of liquidity to meet
its obligations. At October 31, 1997, the investment portfolio, measured at fair
value, including accrued investment income, trades pending settlement and cash
and cash equivalents, was $1,693.5 million compared with $1,531.3 million at
October 31, 1996. The portfolio is made up of fixed maturities, equity
securities, short-term investments and cash and cash equivalents. At October 31,
1997, 84.7% of the fair value of debt securities held was in U.S. Government
securities or in obligations rated A or better by Moody's Investors Service Inc.
or Standard & Poor's Corporation. These securities represented 95.0% of the fair
value of the portfolio at October 31, 1996. The Company presently has no
investments in real estate or mortgage loans.
The Company has committed to invest up to $18.7 million, principally as a
special limited partner, in The Trident Partnership L.P., a limited partnership
organized for investment in the insurance industry. At October 31, 1997, the
investment in Trident was $5.7 million compared with $6.9 million at October 31,
1996.
1997 [LOGO] MID OCEAN LIMITED ANNUAL REPORT
<PAGE> 12
In August 1997, the Company completed the acquisition of Brockbank by
acquiring the remaining 49%, for a cost of $144.4 million, utilizing cash, loan
notes, and the issuance of Class A ordinary shares. The loan notes outstanding
at October 31, 1997, are $10.6 million. Interest is payable on these notes
semi-annually at a rate of 0.5% below LIBOR. These loan notes are redeemable at
the option of the holder under various conditions and any loan notes outstanding
at June 30, 2003 will be redeemed in full at par.
In 1997, the Company 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. There has been no drawdown on these
facilities.
Under the terms of certain reinsurance contracts, Mid Ocean Reinsurance is
required to provide letters of credit to reinsureds in respect of loss reserves
and/or unearned premiums. Mid Ocean Reinsurance has a facility of approximately
$275.2 million provided for the issuing of letters of credit. This facility is
secured by a lien on a portion of Mid Ocean Reinsurance's investment portfolio.
At October 31, 1997, Mid Ocean Reinsurance had provided letters of credit
amounting to $187.9 million compared with $164.8 million at October 31, 1996. In
addition, the Company has largely funded the capital requirements of the two
dedicated corporate syndicates by letters of credit amounting to $109.0 million
at October 31, 1997 (1996: $78 million).
The United States dollar is the Company's functional currency. However,
certain of the Company's assets and liabilities are denominated in currencies
other than the United States dollar. These balances are revalued at exchange
rates current at each balance sheet date. Future losses in currencies other than
the United States dollar represent a potential for foreign exchange exposure.
The Company therefore expects that it could experience exchange gains or losses
that, in turn, could affect the Company's consolidated statement of operations.
The Company generally has not sought to hedge its currency exposures with
respect to such losses before the occurrence of an event that produces a claim.
However, certain of the Company's future cash flows are denominated in component
currencies of its expected liability profile and it may hold investments, cash
and cash equivalents denominated in some of these currencies; thus the currency
exposure on the underlying risks is reduced to some extent.
MANAGEMENT'S DISCUSSION AND ANALYSIS
25
<PAGE> 13
The Company formed a committee during 1997 to address the Year 2000 issue
and its potential impact on the Company. Consideration is being given to
computer systems that the Company uses internally and does have some direct
influence and control over, together with those of third parties by whom the
Company could be significantly affected and over whom the Company does not have
control. These third parties who provide information upon which the Company
relies include intermediaries, banks, investment managers, software companies
and cedents. The Company is developing a formal testing plan to ensure that its
systems are Year 2000 compliant. Such testing has already begun and will
escalate in 1998. Based on the testing and inquiries, the Company will be in a
position to judge the need to change, update and/or acquire systems that are
Year 2000 compliant.
Accounting Standards
See Note 19 to the consolidated financial statements on page 49 for a discussion
of new accounting standards.
Outlook
Future results cannot be predicted. Management believes the pricing pressure
experienced by the insurance and reinsurance markets in 1997 will most likely
continue in 1998 and certain ceding companies may continue to increase
retentions while some may increase the upper limits of their reinsurance
programs. As a result, premiums in several segments of Mid Ocean Reinsurance's
book of business may decrease, compared to fiscal 1997. However, gross premiums
written by the corporate syndicates are expected to increase primarily as a
result of a 47% increase in their capacity in 1998.
The Company's future profitability is dependent on many factors, most
prominent of which is the overall loss experience of its two primary operating
subsidiaries. Such experience is impossible to predict. Management expects that
the increasing size of the corporate syndicates will have an impact on the
Company's businesses and on the financial results of the Company. The addition
of the corporate syndicates will add net
1997 [LOGO] MID OCEAN LIMITED ANNUAL REPORT
<PAGE> 14
premiums written and historically their combined ratios have been higher than
those that have been experienced by the Company to date.
Certain statements made in this document, including in this Management's
Discussion and Analysis, may be considered forward-looking statements within the
meaning of section 27A of the United States Securities Act of 1933, as amended,
and Section 21E of the United States Securities Exchange Act of 1934, as
amended. Many factors may affect the accuracy of such statements, including (i)
the frequency and severity of catastrophic events; (ii) a change in the demand
for or pricing of property catastrophe or other reinsurance or insurance; (iii)
an increase in the supply of property catastrophe reinsurance or other
reinsurance or insurance; (iv) increased competitive pressure, including the
consolidation and increased globalization of reinsurance providers; (v) the
availability of, and pricing of, retrocessions; (vi) loss of the services of any
of the Company's executive officers; (vii) actual losses and loss expenses
exceeding the Company's reserve for losses and loss expenses; (viii) changing
rates of inflation and other general economic conditions; (ix) losses due to
foreign currency exchange rate fluctuations; and (x) changes in or new
applications of the legal or regulatory frameworks in which the Company
operates. 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. The Company undertakes no obligation to release
publicly the results of any future revisions it may make to forward-looking
statements to reflect events or circumstances after the date hereof or to
reflect the occurrence of unanticipated events.
MANAGEMENT'S DISCUSSION AND ANALYSIS
27
<PAGE> 15
CONSOLIDATED BALANCE SHEETS
YEARS ENDED OCTOBER 31, 1997 AND 1996
(Expressed in thousands of United States Dollars)
<TABLE>
<CAPTION>
ASSETS 1997 1996
<S> <C> <C>
Investments available for sale: (notes 3 and 11(c))
Fixed maturities at fair value $ 1,502,213 $ 1,360,210
(amortized cost $1,484,353; 1996: $1,353,056)
Equity securities at fair value (cost $22,388) 23,539 --
Short-term investments at fair value 21,092 26,435
(amortized cost $21,087; 1996: $26,226)
Total investments available for sale 1,546,844 1,386,645
Unquoted investments at cost (note 11(e)) 9,880 7,914
Cash and cash equivalents 122,784 163,968
Accrued investment income 22,076 24,106
Premiums receivable (note 11(c)) 280,792 276,360
Funds withheld by cedents 20,963 8,696
Outstanding losses recoverable from reinsurers (notes 5 and 6) 17,792 5,466
Prepaid reinsurance premiums 14,679 15,846
Profit commissions receivable 32,484 50,338
Investments pending settlement (note 11(b)) 1,809 --
Deferred acquisition expenses 45,856 42,647
Goodwill (note 4) 112,506 24,416
Other assets 42,140 16,297
----------- -----------
TOTAL ASSETS 2,270,605 2,022,699
----------- -----------
LIABILITIES
Losses and loss expenses (note 6) 496,952 427,717
Unearned premiums 321,845 303,340
Investments pending settlement (note 11(b)) -- 43,374
Reinsurance balances payable 12,973 5,870
Loan notes (note 9) 10,573 --
Other liabilities 55,301 72,525
----------- -----------
TOTAL LIABILITIES 897,644 852,826
----------- -----------
Minority interest -- 52,674
----------- -----------
TOTAL LIABILITIES AND MINORITY INTEREST 897,644 905,500
----------- -----------
SHAREHOLDERS' EQUITY
Ordinary shares (par value $0.20, authorized 200,000,000; 7,797 6,880
Issued and outstanding 38,984,080; 1996: 34,401,576) (notes 7 and 8)
Additional paid in capital 740,538 625,048
Net unrealized appreciation on investments 18,679 6,920
Foreign currency translation adjustments 386 99
Deferred compensation (5,286) (2,058)
Retained earnings 610,847 480,310
----------- -----------
TOTAL SHAREHOLDERS' EQUITY 1,372,961 1,117,199
----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 2,270,605 $ 2,022,699
----------- -----------
</TABLE>
See accompanying notes to consolidated financial statements.
1997 [LOGO] MID OCEAN LIMITED ANNUAL REPORT
<PAGE> 16
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED OCTOBER 31, 1997, 1996 AND 1995
(Expressed in thousands of United States Dollars except for share data)
<TABLE>
<CAPTION>
REVENUES 1997 1996 1995
<S> <C> <C> <C>
Gross premiums written (notes 10, 11(c) and 16) $ 560,505 $ 566,287 $ 445,819
Premiums ceded 55,022 40,615 10,842
Net premiums written (note 5) 505,483 525,672 434,977
Change in unearned premiums 18,742 89,575 55,587
Net premiums earned (notes 5 and 10) 486,741 436,097 379,390
Net investment income (note 3) 103,429 83,261 73,835
Net gains on investments 9,603 2,126 1,476
Exchange loss (note 17) (10,004) (1,597) (2,436)
Managing agency income (note 10) 20,944 14,391 --
Other income 8,658 4,838 --
---------------------------------------------------
TOTAL REVENUES 619,371 539,116 452,265
---------------------------------------------------
EXPENSES
Losses and loss expenses incurred 242,286 216,458 200,061
Reinsurance recoveries 26,115 4,570 1,411
Net losses and loss expenses incurred (note 6) 216,171 211,888 198,650
Acquisition expenses 85,902 70,125 53,352
Managing agency expenses 4,892 4,969 --
Operational expenses 53,953 34,402 16,715
Organizational expenses -- -- 613
---------------------------------------------------
TOTAL EXPENSES 360,918 321,384 269,330
---------------------------------------------------
Income before tax and minority interest 258,453 217,732 182,935
Income taxes (note 14) (11,772) (4,478) --
Minority interest (1,673) (1,610) --
---------------------------------------------------
NET INCOME $ 245,008 $ 211,644 $ 182,935
---------------------------------------------------
PER SHARE DATA
Net income per ordinary share $ 6.46 $ 5.75 $ 4.90
---------------------------------------------------
Weighted average number of ordinary and ordinary 37,926,963 36,838,957 37,346,503
equivalent shares outstanding ---------------------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements.
CONSOLIDATED FINANCIAL STATEMENTS
29
<PAGE> 17
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED OCTOBER 31, 1997, 1996 AND 1995
(Expressed in thousands of United States Dollars)
<TABLE>
<CAPTION>
ORDINARY SHARES 1997 1996 1995
<S> <C> <C> <C>
Balance at beginning of year $ 6,880 $ 6,911 $ 7,255
Issuance of shares 967 44 9
Repurchase of shares (50) (75) (353)
----------- ----------- ---------
Balance at end of year 7,797 6,880 6,911
----------- ----------- ---------
ADDITIONAL PAID IN CAPITAL
Balance at beginning of year 625,048 632,926 680,434
Issuance of shares 127,924 5,491 1,068
Repurchase of shares (12,434) (13,369) (48,576)
----------- ----------- ---------
Balance at end of year 740,538 625,048 632,926
----------- ----------- ---------
NET UNREALIZED APPRECIATION (DEPRECIATION) ON INVESTMENTS
Balance at beginning of year 6,920 13,789 (41,772)
Net change for year 11,759 (6,869) 55,561
----------- ----------- ---------
Balance at end of year 18,679 6,920 13,789
----------- ----------- ---------
FOREIGN CURRENCY TRANSLATION ADJUSTMENTS
Balance at beginning of year 99 -- --
Translation adjustments for the year 287 99 --
----------- ----------- ---------
Balance at end of year 386 99 --
----------- ----------- ---------
DEFERRED COMPENSATION
Balance at beginning of year (2,058) -- --
Issuance of shares (7,619) (3,135) --
Amortization 4,391 1,077 --
----------- ----------- ---------
Balance at end of year (5,286) (2,058) --
----------- ----------- ---------
RETAINED EARNINGS
Balance at beginning of year 480,310 315,168 158,656
Net income 245,008 211,644 182,935
Dividends paid (114,471) (46,502) (26,423)
Balance at end of year 610,847 480,310 315,168
----------- ----------- ---------
TOTAL SHAREHOLDERS' EQUITY $ 1,372,961 $ 1,117,199 $ 968,794
----------- ----------- ---------
</TABLE>
See accompanying notes to consolidated financial statements.
1997 [LOGO] MID OCEAN LIMITED ANNUAL REPORT
<PAGE> 18
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED OCTOBER 31, 1997, 1996 AND 1995
(Expressed in thousands of United States Dollars)
<TABLE>
<CAPTION>
CASH FLOWS FROM OPERATING ACTIVITIES 1997 1996 1995
<S> <C> <C> <C>
Net income $ 245,008 $ 211,644 $ 182,935
Adjustments to reconcile net income
to cash provided by operating activities:
Amortization of premiums on investments 2,033 9,207 3,073
Amortization of goodwill 2,777 1,500 --
Amortization of deferred compensation 4,391 1,077 --
Net gains on investments (9,603) (2,126) (1,476)
Premiums receivable (2,571) (73,598) (55,822)
Deferred acquisition expenses (2,675) (19,873) (4,478)
Outstanding losses recoverable from reinsurers (12,339) 1,595 2,736
Prepaid reinsurance premiums 1,432 (10,370) (632)
Losses and loss expenses 68,881 91,666 111,233
Unearned premiums 15,791 97,005 51,272
Reinsurance balances payable 7,042 5,870 --
Funds withheld by cedents (12,317) (4,165) (2,130)
Other (24,897) 21,215 4,157
----------- ----------- -----------
Net cash provided by operating activities 282,953 330,647 290,868
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sale and maturity of fixed maturities 4,694,393 3,285,221 3,230,775
Purchase of fixed maturities (4,862,020) (3,545,275) (3,413,488)
Proceeds from sale of equity securities 3,116 -- --
Purchase of equity securities (25,301) -- --
Gains (losses) on forward contracts 4,142 (760) 507
Settlement of futures contracts (1,542) -- --
Proceeds from sale of unquoted investments 2,046 -- --
Purchase of unquoted investments (3,192) (4,461) (2,856)
Net investment in Brockbank Group (74,878) (59,106) --
----------- ----------- -----------
Net cash applied to investing activities (263,236) (324,381) (185,062)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Options exercised 64,646 2,400 25
Repurchase of share capital (12,484) (13,444) (48,929)
Dividends paid (114,471) (46,502) (26,423)
----------- ----------- -----------
Net cash applied to financing activities (62,309) (57,546) (75,327)
----------- ----------- -----------
FOREIGN CURRENCY TRANSLATION ADJUSTMENT 1,408 200 --
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (41,184) (51,080) 30,479
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 163,968 215,048 184,569
----------- ----------- -----------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 122,784 $ 163,968 $ 215,048
----------- ----------- -----------
Income taxes paid $ 5,806 $ 2,210 $ --
----------- ----------- -----------
</TABLE>
See accompanying notes to consolidated financial statements.
CONSOLIDATED FINANCIAL STATEMENTS
31
<PAGE> 19
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED OCTOBER 31, 1997, 1996 AND 1995
(Expressed in thousands of United States Dollars except for share data)
1. GENERAL
The Company was incorporated in April 1993 under the laws of the Cayman Islands
as Mid Ocean Reinsurance Holdings Company Ltd. By resolution of the members, the
Company's name was changed to Mid Ocean Limited ("the Company") in May 1993.
In June 1993, the Company acquired the entire issued share capital of Mid
Ocean Reinsurance Company Ltd. ("Mid Ocean Reinsurance") by an exchange of six
shares of the Company for each share of Mid Ocean Reinsurance. At the same time,
each option to purchase a share of Mid Ocean Reinsurance that was granted to
officers and directors was exchanged for options to purchase six shares of the
Company. Mid Ocean Reinsurance was incorporated in August 1992 under the laws of
Bermuda and is licensed under the Insurance Act 1978 of Bermuda to write
insurance business.
Mid Ocean Reinsurance commenced operations in November 1992 and 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. In 1995, Mid Ocean Reinsurance's London branch
commenced underwriting marine and energy and aviation reinsurance on a worldwide
basis.
In late 1995, the shareholders of The Brockbank Group plc ("Brockbank")
agreed to combine the business of its subsidiaries, principally a Lloyd's
managing agency, with a subsidiary of Mid Ocean Reinsurance which, in turn,
invested $79,756 in two new Lloyd's dedicated corporate syndicates. Such
combination resulted in the formation of the Brockbank Group. As a result of
this combination, Mid Ocean Reinsurance acquired 51% of the Brockbank Group. In
August 1997, the Company completed the acquisition of the remaining 49% of the
Brockbank Group for a cost of $144,360. The corporate syndicates write property,
marine and energy, aviation and satellite, professional indemnity, motor and
other speciality lines primarily of insurance but also reinsurance.
In August 1996, Mid Ocean Reinsurance established Mid Ocean Reinsurance
Consulting GmbH, a wholly owned subsidiary located in Munich, Germany, which is
Mid Ocean Reinsurance's European contact office. Effective September 1996, Mid
Ocean Reinsurance received approval from the Monetary Authority of Singapore to
open a branch in Singapore. The branch office commenced writing general
reinsurance, treaty and facultative business in November 1996.
In 1997, subsequent to completion of the acquisition of the Brockbank Group,
the Company formed Mid Ocean Holdings Limited ("Holdings") as a new wholly owned
subsidiary. Holdings has two wholly owned subsidiaries, Mid Ocean Reinsurance
and Ridgewood Holdings Ltd. ("Ridgewood"). Ridgewood is the Bermuda holding
company of Brockbank.
A significant portion of the Company'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.
It is the policy of Mid Ocean Reinsurance to limit the amount of aggregate
exposure emanating from the direct catastrophe excess of loss portfolio in the
major areas in the world, such that the Company would not be significantly
impaired in the event of a major loss event in those areas actively
underwritten by the Company. Aggregate limits from such business currently
range from $200 million to $600 million according to territory.
Attachment points vary with each reinsurance contract written and Mid Ocean
Reinsurance generally prefers to participate on several different layers of a
reinsurance program to achieve both a vertical spread, as well as a geographic
spread, of risk assumed.
1997 [LOGO] MID OCEAN LIMITED ANNUAL REPORT
<PAGE> 20
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. SIGNIFICANT ACCOUNTING POLICIES
The accompanying consolidated financial statements of the Company have been
prepared in accordance with United States ("US") generally accepted accounting
principles which require management to make estimates and assumptions that
affect the reported amounts 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 following are the
significant accounting policies adopted by the Company.
(a) BASIS OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and
its subsidiaries. All significant inter-company accounts and transactions have
been eliminated.
The Company's fiscal year end is October 31. Brockbank's fiscal year end is
December 31. Results of operations for the twelve month period ended September
30, 1997 and nine month period ended September 30, 1996 and financial position
at those dates have been included in the consolidated financial statements of
the Company for the years ended October 31, 1997 and 1996 respectively.
(b) PREMIUMS ASSUMED AND CEDED
Premiums written are estimated based on information received from ceding
companies and any subsequent differences arising on such estimates are recorded
in the period in which 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
the policies in force.
Premiums ceded are recorded as incurred on a pro rata basis over the contract
period.
(c) DEFERRED ACQUISITION EXPENSES
Acquisition expenses, mainly commissions and brokerage, related to unearned
premiums are deferred and amortized over the period the coverage is provided.
Anticipated losses and other expenses related to those premiums are considered
in determining the recoverability of deferred acquisition expenses.
(d) LOSSES AND LOSS EXPENSES
The liability for losses and loss expenses includes liabilities for unpaid
reported losses and loss expenses and for losses incurred but not reported
("IBNR"). The liability for unpaid reported losses and loss expenses is
established by management based upon reports received from ceding companies and
insureds supplemented with the Company's case reserve estimates. The Company
only has five years' loss history and accordingly the liability for IBNR has
been established by management in consultation with independent actuaries and is
based on Company and industry experience and judgement. Amounts recoverable from
reinsurers are estimated in a manner consistent with the underlying liabilities.
Management believes that the liability for losses and loss expenses and IBNR
is adequate to cover the ultimate cost of losses and loss expenses incurred.
However, such liability is necessarily an estimate and therefore the amount
ultimately paid may be more or less than such an estimate. The methodology
CONSOLIDATED FINANCIAL STATEMENTS
33
<PAGE> 21
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
of estimating the liability is periodically reviewed to ensure that the
assumptions made continue to be appropriate and any adjustments resulting
therefrom are reflected in income in the period the adjustments are made.
(e) INVESTMENTS
Investments available for sale are carried at fair value. Fair values of
investments are based on quoted market values where available or by reference to
broker bid indications. The net unrealized appreciation or depreciation on
investments available for sale is included as a separate component of
shareholders' equity. Investments are recorded on a trade date basis with
balances pending settlement accrued in the balance sheet. Realized gains and
losses on sales of investments are determined on the basis of average cost. Net
investment income is recognized when earned and includes the amortization of
premium or discount on investments and interest payable on loan notes.
Short-term investments include investments with a maturity of greater than
ninety days but less than one year.
Unquoted investments comprise investments in companies for which there is no
quoted market price. It is not practicable to estimate the fair value of the
investments and thus they are carried at original cost.
The Company uses foreign currency forward contracts to manage the investment
portfolio exposure to foreign currency fluctuations. The Company enters into
contracts to enhance investment returns and to hedge individual foreign currency
investments. Realized and unrealized gains and losses on open and closed forward
exchange contracts designated as hedges of foreign currency investments are
deferred and included in shareholders' equity until the hedged investments are
sold. Realized and unrealized gains and losses on contracts that are not
designated as hedges are included in income. Fair values for foreign currency
forward contracts are based on contract prices and are revalued at exchange
rates in effect at the balance sheet date.
The Company utilizes financial futures for yield enhancement. Realized and
unrealized gains and losses on futures contracts that are not designated as
hedges are included in income. Collateral held by buyers equal to a percentage
of the total value of open futures contracts is included in investments
available for sale. Fair values for futures contracts are based on prices quoted
on the futures exchanges.
(f) TRANSLATION OF FOREIGN CURRENCIES
All assets and liabilities in the balance sheets of foreign subsidiaries
whose functional currency is other than the US dollar are translated at the year
end exchange rates, except the Brockbank Group, which is translated at September
30, 1997 and 1996. Revenue and expense items are translated at average exchange
rates prevailing during the year. Translation gains and losses are not included
in determining net income but are accumulated as a separate component of
shareholders' equity.
Foreign currency assets and liabilities in the balance sheets of subsidiaries
whose functional currency is the US dollar are translated at exchange rates in
effect at the balance sheet date. Unearned
1997 [LOGO] MID OCEAN LIMITED ANNUAL REPORT
<PAGE> 22
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
premium and deferred acquisition expenses are translated at historic rates.
Foreign currency revenues and expenses are translated at the average exchange
rates prevailing during the year and exchange gains and losses are included in
the determination of net income.
(g) MANAGING AGENCY INCOME
Managing agency income includes fees earned by the Brockbank managing agency
in respect of its management of Lloyd's underwriting syndicates. It also
includes earned profit commissions which are estimated by management based on
anticipated results of the syndicates managed by Brockbank. Profit commissions
are settled once a Lloyd's underwriting year has been closed after three years.
(h) DEPRECIATION AND AMORTIZATION
Depreciation of fixed assets is provided on a straight line basis over their
estimated useful lives ranging from 3 to 5 years.
Goodwill related to the acquisition of Brockbank is amortized on a straight
line basis over 15 years.
(i) INCOME TAXES
The Company records its income tax liability and deferred tax asset in
accordance with Statement of Financial Accounting Standards (SFAS) No. 109,
under which the Company records deferred income taxes which reflect the net tax
effect of the temporary differences between the carrying amounts of assets and
liabilities for financial reporting purposes and their respective tax bases.
(j) CASH AND CASH EQUIVALENTS
For the purposes of the statements of cash flows, cash equivalents include
money market instruments with a maturity of ninety days or less when purchased.
(k) INCOME PER ORDINARY SHARE
Income per ordinary share is based upon the weighted average number of
ordinary shares outstanding and, if dilutive, shares issuable under outstanding
options. There is no material difference between primary and fully diluted net
income per ordinary share.
(l) PREMIUMS RECEIVABLE
Premiums receivable are stated net of any allowance for doubtful accounts.
(m) STOCK-BASED COMPENSATION
The Company adopted SFAS No. 123 "Accounting for Stock-Based Compensation"
effective November 1, 1995. As allowed under this standard, the Company has
chosen to follow the provisions of Accounting Principles Board Opinion No. 25.
Pro forma disclosure of net income and earnings per share as if the fair value
based method of SFAS No. 123 had been adopted is provided in note 8.
3. INVESTMENTS AVAILABLE FOR SALE
(a) FIXED MATURITIES AND SHORT-TERM INVESTMENTS
Amortized cost, fair value and related unrealized gains or losses on fixed
maturities and short-term investments are as follows:
CONSOLIDATED FINANCIAL STATEMENTS
35
<PAGE> 23
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
AMORTIZED GROSS GROSS FAIR
COST UNREALIZED UNREALIZED VALUE
1997 FIXED MATURITIES: GAINS LOSSES
<S> <C> <C> <C> <C>
US government and
government agency bonds $ 305,113 $ 3,141 $ (91) $ 308,163
Taxable municipal bonds 22,533 584 (28) 23,089
Corporate bonds 447,127 11,734 (6,051) 452,810
Non US sovereign government bonds 248,631 5,043 (1,919) 251,755
Asset-backed securities 427,580 4,066 (51) 431,595
Mortgage-backed securities 33,369 1,438 (6) 34,801
--------------------------------------------------------
Total Fixed Maturities $1,484,353 $26,006 $(8,146) $1,502,213
--------------------------------------------------------
SHORT-TERM INVESTMENTS:
Corporate bonds $ 6,050 $ 13 $ (2) $ 6,061
Non US sovereign government bonds 15,037 5 (11) 15,031
--------------------------------------------------------
Total Short-term Investments $ 21,087 $ 18 $ (13) $ 21,092
--------------------------------------------------------
1996 FIXED MATURITIES:
US government and
government agency bonds $ 629,924 $ 5,842 $(1,465) $ 634,301
Corporate bonds 226,738 2,415 (1,995) 227,158
Non US sovereign government bonds 240,524 2,109 (1,190) 241,443
Asset-backed securities 235,758 1,634 (216) 237,176
Mortgage-backed securities 20,112 192 (172) 20,132
--------------------------------------------------------
Total Fixed Maturities $1,353,056 $12,192 $(5,038) $1,360,210
--------------------------------------------------------
SHORT-TERM INVESTMENTS:
US government and
government agency bonds $ 17,546 $ 45 $ -- $ 17,591
Corporate bonds 825 -- -- 825
Non US sovereign government bonds 7,855 164 -- 8,019
--------------------------------------------------------
Total Short-term Investments $ 26,226 $ 209 $ -- $ 26,435
--------------------------------------------------------
</TABLE>
1997 [LOGO] MID OCEAN LIMITED ANNUAL REPORT
<PAGE> 24
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The portfolio of fixed maturities available for sale at October 31, 1997 by
contractual maturity is shown below. Actual maturity of investments 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>
AMORTIZED FAIR
COST VALUE
----------------------------
<S> <C> <C>
Due after one through five years $ 558,099 $ 560,277
Due after five through ten years 195,504 196,859
Due after ten years 269,801 278,681
1,023,404 1,035,817
Mortgage and asset-backed securities 460,949 466,396
----------------------------
$1,484,353 $1,502,213
----------------------------
</TABLE>
(b) EQUITY SECURITIES
The gross unrealized gains and losses on equity securities are as follows:
<TABLE>
<CAPTION>
1997 1996
-----------------------------
<S> <C> <C>
Equity securities at cost $ 22,388 $ --
Gross unrealized gains 1,404 --
Gross unrealized losses (253) --
----------------------------
Equity securities at fair value $ 23,539 $ --
----------------------------
</TABLE>
(c) NET INVESTMENT INCOME
Net investment income was derived from the following sources:
<TABLE>
<CAPTION>
1997 1996 1995
------------------------------------------
<S> <C> <C> <C>
Fixed maturities, short-term investments and other deposits $ 107,376 $ 94,155 $ 79,437
Amortization of premiums on investments (2,033) (9,207) (3,073)
Expenses (1,938) (1,687) (2,529)
Other 24 -- --
$ 103,429 $ 83,261 $ 73,835
-----------------------------------------
</TABLE>
(d) COLLATERAL
Mid Ocean Reinsurance has obtained a facility providing for the issuance of
letters of credit up to $275,183 which is secured by a lien of a similar amount
of the Company's investments. Letters of credit of $187,948 were outstanding at
October 31, 1997 (1996: $164,794). This amount includes $108,982 (1996: $79,738)
in respect of the two Lloyd's corporate syndicates which has been issued in lieu
of capital.
CONSOLIDATED FINANCIAL STATEMENTS
37
<PAGE> 25
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As at October 31, 1997, $1,700 (1996: $nil) of investments are pledged as
collateral for financial futures contracts.
4. ACQUISITIONS
In December 1995, the shareholders of The Brockbank Group plc agreed to combine
the business of its subsidiaries, principally a Lloyd's managing agency, with a
subsidiary of Mid Ocean Reinsurance, which in turn invested $79,756 in two new
Lloyd's dedicated corporate syndicates. Such combination resulted in the
formation of the Brockbank Group. As a result of this combination, Mid Ocean
Reinsurance acquired 51% of the Brockbank Group. The fair value of net assets
acquired was $54,179 and goodwill was $25,577.
In August 1997, the Company completed the acquisition of the remaining 49% of
the Brockbank Group for a cost of $144,360 which includes expenses of $4,472. As
of October 31, 1997 approximately $81,305 was in the form of cash and loan notes
and $55,583 through the issuance of 948,192 Class A ordinary shares which are
subject to certain transfer restrictions and 34,306 options to purchase Class A
ordinary shares. In addition, included in other liabilities at October 31, 1997
is an accrual of $3,000 in respect of $2,666 cash to be paid and loan notes and
4,954 Class A ordinary shares to be issued in November 1997. The fair value of
the net assets acquired was $53,493 and goodwill was $90,867.
Both investments have been accounted for under the purchase method and
goodwill arising is being amortized on a straight line basis over 15 years from
the date of acquisition.
<TABLE>
<CAPTION>
1997 1996 1995
<S> <C> <C> <C>
Goodwill at start of year $ 24,416 $-- $--
Additions 90,867 25,577 --
Purchased goodwill -- 339 --
Amortization (2,777) (1,500) --
Goodwill at end of year $ 112,506 $ 24,416 $--
</TABLE>
5. REINSURANCE
Reinsurance premiums ceded are in respect of common account protection purchased
by the Company on certain proportional reinsurance treaties together with the
purchase of reinsurance protection on certain aspects of its book of business.
The Company is contingently liable with respect to reinsurance ceded to the
extent that any reinsurance company fails to meet its obligation. The Company
regularly monitors the financial condition of its reinsurers and believes all
amounts due to be recoverable.
1997 [LOGO] MID OCEAN LIMITED ANNUAL REPORT
<PAGE> 26
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The effect of reinsurance on premiums written and earned is as follows:
<TABLE>
<CAPTION>
1997 1996 1995
Written Earned Written Earned Written Earned
<S> <C> <C> <C> <C> <C> <C>
Direct $143,184 $ 83,209 $ 94,350 $ 36,329 $ -- $ --
Assumed 417,321 460,216 471,937 429,692 445,819 389,600
Ceded (55,022) (56,684) (40,615) (29,924) (10,842) (10,210)
-------- -------- -------- -------- -------- --------
Net Premiums $505,483 $486,741 $525,672 $436,097 $434,977 $379,390
-------- -------- -------- -------- -------- --------
</TABLE>
6. LOSSES AND LOSS EXPENSES
The movement in the net liability for losses and loss expenses is summarized
below:
<TABLE>
<CAPTION>
1997 1996 1995
<S> <C> <C> <C>
Balance at beginning of year $ 427,717 $ 336,051 $ 224,818
Less reinsurance recoverables 5,466 7,061 9,797
--------- --------- ---------
Net balance at beginning of year 422,251 328,990 215,021
--------- --------- ---------
Incurred related to:
Current year 321,449 281,402 245,750
Prior years (105,278) (69,514) (47,100)
--------- --------- ---------
Total incurred 216,171 211,888 198,650
--------- --------- ---------
Paid related to:
Current year 61,287 36,397 25,981
Prior years 97,975 82,230 58,700
--------- --------- ---------
Total paid 159,262 118,627 84,681
--------- --------- ---------
Net balance at end of year 479,160 422,251 328,990
Plus reinsurance recoverables 17,792 5,466 7,061
--------- --------- ---------
Balance at end of year $ 496,952 $ 427,717 $ 336,051
--------- --------- ---------
</TABLE>
As a result of the settlement of claims and changes in estimates of reinsured
events, the net incurred losses and loss expenses attributable to prior years
decreased by $105,278 in the current year (1996: $69,514; 1995: $47,100).
The Company has relied on and consistently applied the Bornhuetter-Ferguson
incurred loss actuarial method for estimating its loss reserves. Due to a
relatively low level of losses as compared to historical industry experience,
actual losses have not developed in accordance with initial estimates made by
management. This has resulted in the favorable loss development indicated above.
CONSOLIDATED FINANCIAL STATEMENTS
39
<PAGE> 27
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. SHARE CAPITAL AND ADDITIONAL PAID IN CAPITAL
The authorized share capital of the Company is $40,000 comprised of 200,000,000
ordinary shares with a par value of $0.20 each. The share capital may be used as
Class A, Class B or Class C shares. As of October 31, 1997, 1996 and 1995, the
following shares have been issued and fully paid:
<TABLE>
<CAPTION>
1997 1996 1995
Shares Share Additional Shares Share Additional Shares Share Additional
Issued Capital Paid in Issued Capital Paid in Issued Capital Paid in
Capital Capital Capital
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Class A 35,933,788 $ 7,425 $ 709,904 32,541,576 $ 6,508 $ 594,414 32,503,192 $ 6,501 $ 599,494
Class B 1,190,292 -- -- -- -- -- -- -- --
Class C 1,860,000 372 30,634 1,860,000 372 30,634 2,052,000 410 33,432
---------- --------- ----------- ---------- ------- ----------- ---------- ------- -----------
38,984,080 $ 7,797 $ 740,538 34,401,576 $ 6,880 $ 625,048 34,555,192 $ 6,911 $ 632,926
---------- --------- ----------- ---------- ------- ----------- ---------- ------- -----------
</TABLE>
Holders of Class A shares are entitled to one vote for each share held. Class
B shares are entitled to one tenth vote per share and Class C shares are not
entitled to vote. In all other respects, Class A, B and C shares rank pari
passu. There are also certain restrictions relating to the transfer of shares.
In October 1995, the Company completed a secondary offering of 4,203,600
ordinary shares (the "Secondary") priced to the public at $33.75 per share. All
shares offered were sold by existing shareholders and no proceeds of the
Secondary were received by the Company.
The following is a summary of shares issued and outstanding:
<TABLE>
<CAPTION>
1997 1996 1995
<S> <C> <C> <C>
Balance at beginning of year 34,401,576 34,555,192 36,274,192
Exercise of options 3,787,562 139,884 1,500
Shares issued in Brockbank acquisition 948,192 -- --
Share grants 96,750 82,500 44,500
Repurchase of shares (250,000) (376,000) (1,765,000)
---------- ---------- ----------
Balance at end of year 38,984,080 34,401,576 34,555,192
---------- ---------- ----------
</TABLE>
During the year ended October 31,1997 3,363,870 (1996: nil; 1995: nil)
options exercised related to Mid Ocean Reinsurance options issued to certain of
its founding shareholders in 1993.
In September 1996, the Company announced that its Board of Directors adopted
a shareholder rights plan. The Company adopted the plan to protect shareholders
against unsolicited attempts to acquire control of the Company that do not offer
what the Company believes to be an adequate price to all shareholders. The plan
has been designed to allow EXEL Limited ("EXEL"), a principal shareholder, to
maintain its existing holdings. The rights were issued to shareholders of record
on
1997 [LOGO] MID OCEAN LIMITED ANNUAL REPORT
<PAGE> 28
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
October 1, 1996. The plan provides for the issuance of one right for each Class
A ordinary share. Each right entitles the holder to purchase from the Company
one Class A ordinary share at an initial price of $140.00.
The rights will become exercisable and will detach from the Class A ordinary
shares a specified period of time after any person has become the beneficial
owner of 20% or more of the Company's common shares or commenced a tender or
exchange offer which, if consummated, would result in any person becoming the
beneficial owner of 20% or more of the common shares. Persons (such as EXEL)
owning 20% or more of the common shares of the Company on the date the plan was
adopted, and certain transferees of such persons, would not cause the rights to
become exercisable subject to certain limitations on such persons' ability to
acquire additional common shares.
If any person becomes the beneficial owner of 20% or more of the Company's
common shares (other than persons referred to in the previous sentence), each
right will entitle the holder, other than the acquiring person, to purchase for
the then applicable purchase price, the Company's common shares having a value
of twice the purchase price.
If, following an acquisition of 20% or more of the Company's common shares,
the Company is involved in certain mergers or other business combinations or
sells or transfers more than 50% of its assets or earning power, each right will
entitle the holder to purchase for the then applicable purchase price common
stock of the other party to such transaction having a value of twice the
purchase price.
At any time after a person has acquired 20% or more (but before any person
has acquired more than 50%) of the Company's common shares, the Company may
exchange all or part of the rights for common shares at an exchange ratio of one
Class A ordinary share per right, subject to rights holders delivering to the
Company an amount in cash equal to the par value of each Class A ordinary share
to be received.
The Company may redeem the rights at a price of $0.01 per right at any time
prior to a specified period of time after a person has become the beneficial
owner of 20% or more of its common shares. The rights will expire on October 1,
2006, unless earlier exchanged or redeemed.
8. SHARE PURCHASE OPTIONS AND SHARE AWARD PLAN
The Company has adopted its 1993 Long-Term Incentive and Share Award Plan ("the
Plan"). The Plan is designed to provide a means to attract, retain and motivate
employees in order to achieve the long-term growth and profitability objectives
of the Company. The Plan provides for the issuance of options and other
stock-based awards covering up to an aggregate of 2,250,000 ordinary shares. The
Company has recorded compensation expenses of $4,391 in respect of share grants
and options (1996: $1,077; 1995: $nil). Deferred compensation represents 108,320
share grants not vested at October 31, 1997.
Had the compensation cost for this plan been determined consistent with the
fair value method recommended in SFAS No. 123, the Company's net income and
earnings per share would have been reduced to the following pro forma amounts:
CONSOLIDATED FINANCIAL STATEMENTS
41
<PAGE> 29
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
Net income As reported $ 245,008 $ 211,644
Pro forma $ 243,640 $ 211,309
Earnings per share As reported $ 6.46 $ 5.75
Pro forma $ 6.42 $ 5.74
</TABLE>
The pro forma compensation cost may not be representative of that to be
expected in future years.
The Company has issued a number of share purchase options to shareholders,
officers and employees of the Company. These options are exercisable within a
period of ten years from the date of the award. Each non-management director is
granted an option each year to purchase 1,500 shares from the Company. The
following is a summary of the options granted and outstanding:
<TABLE>
<CAPTION>
1997 1996 1995
Number Weighted Av. Number Weighted Av. Number Weighted Av.
of shares exercise price of shares exercise price of shares exercise price
<S> <C> <C> <C> <C> <C> <C>
Outstanding at
beginning of year 903,454 $22.99 947,838 $20.61 894,838 $20.35
Granted 220,000 $47.73 95,500 $38.08 54,500 $24.82
Issued to holders of
Brockbank options 34,306 $14.23 -- -- -- --
Exercised (412,392) $20.83 (139,884) $17.16 (1,500) $16.67
Outstanding at
end of year 745,368 $31.09 903,454 $22.99 947,838 $20.61
Exercisable at
end of year 479,123 $26.97 661,054 $20.85 663,674 $19.01
</TABLE>
The weighted average fair value of options granted in 1997 was $13.75 (1996:
$12.50). The 745,368 (1996: 903,454) options outstanding at October 31,1997 have
exercise prices between $10.67 and $57.75 (1996: $16.67 and $40.25), with a
weighted average exercise price of $31.09 (1996: $22.99).
Of the 745,368 (1996: 903,454; 1995: 947,838) options granted to officers and
directors, 479,123 (1996: 661,054; 1995: 663,674) are presently exercisable. The
remaining options are not presently exercisable and of these, 160,485 (1996:
nil; 1995: 29,564) vest over a three year period from the date of the award, and
105,760 (1996: 242,400; 1995: 254,600) vest over a five year period from the
date of the award.
1997 [LOGO] MID OCEAN LIMITED ANNUAL REPORT
<PAGE> 30
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 used for grants in 1997: risk-free interest rate of 5.52%; expected
dividend yield of 3.45%; expected life of 10 years; expected volatility of
27.34%.
In the event that prior to the expiration of the options there occurs any
change in the number or nature of the shares outstanding by reason of certain
events, the number of shares subject to the options and the option price shall
be adjusted accordingly.
9. LOAN NOTES
In connection with the acquisition of the remaining 49% of the Brockbank Group
on August 18, 1997, the Company has issued loan notes of 6,315 British pounds.
Interest is payable on these notes semi-annually at a rate of 0.5% below LIBOR.
The semi-annual LIBOR rate at October 31st was 5.785%. The loan notes are
redeemable at the option of the holder on June 30 or December 31 in any year
commencing on June 30, 1998, up to June 30, 2003. If at any time after June 30,
1998, 90% of the nominal amount of the loan notes issued have been redeemed,
repaid or cancelled the Company has the right to redeem all of the remaining
loan notes. Any loan notes outstanding at June 30, 2003 will be redeemed in
full at par.
10. RELATED PARTY TRANSACTIONS
One of the Company's subsidiaries is a managing agency at Lloyd's which manages
a syndicate which ceded premium to Mid Ocean Reinsurance in 1997 and 1996. Gross
premiums written for this contract were $9,556 for the year ended October 31,
1997 (1996: $18,790). The Company also recorded earned profit commission and fee
income of $20,944 for the year ended October 31, 1997 (1996: $14,391) for the
managing agency in respect of its management of Lloyd's syndicates.
In April 1996, the Company entered into a three year reinsurance agreement
with X.L. Reinsurance Company Ltd., a subsidiary of a principal shareholder, for
catastrophe excess of loss protection. This contract was cancelled and renewed
for a further three year period effective April 1, 1997. Net premiums earned
include an expense relating to this contract for the year ended October 31, 1997
of $2,583 (1996: $1,167). There have been no loss recoveries recorded to date on
this contract.
11. COMMITMENTS AND CONTINGENCIES
(a) COMMITMENTS
The Company has rented space for its principal executive offices under leases
which expire up to June 2009. Total rent expense for the year ended October 31,
1997 was approximately $3,062 (1996: $774; 1995: $341). Future minimum rental
payments under the leases are expected to be as follows:
CONSOLIDATED FINANCIAL STATEMENTS
43
<PAGE> 31
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
<S> <C> <C>
Year ending October 31: 1998 $3,062
1999 3,035
2000 2,828
2001 2,194
2002 2,171
Later years 12,486
-------
Total minimum future rentals $25,776
-------
</TABLE>
These minimum future rentals exclude sub-leases.
(b) FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Company utilizes derivative instruments such as foreign currency forward
contracts and futures for purposes other than trading.
(i) Foreign currency forward contracts
The net fair value of the forward foreign exchange contracts at October 31,
1997, included in investments pending settlement, is $221 payable (1996: $976
payable). Forward foreign exchange contracts outstanding at the year end were as
follows:
<TABLE>
<CAPTION>
1997 1996
-------------------------------- ---------------------------------
Notional Principal Notional Principal
Amount Fair Value Amount Fair Value
------------------ ---------- ------------------ ----------
<S> <C> <C> <C> <C>
Receivable $68,809 $69,640 $61,882 $62,048
Payable (68,809) (69,861) (61,882) (63,024)
-------------------------------------------------------------
Net $ 0 $ (221) $ 0 $ (976)
-------------------------------------------------------------
</TABLE>
Included in the table above are forward foreign exchange contracts which have
been closed by the purchase of matching contracts for the delivery of foreign
currency on the same date with an aggregate notional principal amount of $48,580
(1996: $9,408) and a net fair value of $176 payable (1996: $33). The maturity
dates of these contracts range from between 30 and 90 days from the inception
date of the contract. The Company is exposed to credit loss in the event of
non-performance by the other parties to the contracts; however, the Company does
not anticipate non-performance. The difference between the notional principal
amounts and the associated fair value is the Company's maximum credit exposure.
Net gains resulting from forward foreign exchange contracts included in net
gains on investments amounted to $3,393 (1996: losses $2,335; 1995: losses
$8,528).
1997 [MID OCEAN LOGO] MID OCEAN LIMITED ANNUAL REPORT
<PAGE> 32
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(ii) S & P 500 futures
A portion of the Company's investment portfolio is managed as a synthetic
equity index fund whereby S & P 500 futures are held with a nominal value
approximately equal to the market value of short-term investments and fixed
maturities in the specific portfolio. This creates a portfolio that tracks the
performance of the S & P 500 index. As the futures contracts approach expiration
they are rolled forward into subsequent contracts to maintain the equity
exposure. Settlement is made daily in cash by an amount equal to the net change
in market value of the futures contracts. Realized and unrealized gains and
losses on the S & P futures of $50 for the year ended October 31, 1997 (1996:
$nil) are included in income. At October 31, 1997 the fair value of the
synthetic equity fund was $30,410.
(c) CONCENTRATIONS OF CREDIT RISK
The Company does not have any investment in a single corporate security which
exceeds 5% of the carrying value of its investments.
Approximately 5.3% (1996: 4.5%; 1995: 10.3%) of gross premiums written for
the year was in respect of one cedent and $13,752 (1996: $24,096) of reinsurance
premiums receivable are in respect of one cedent.
Four (1996: four; 1995: six) brokers each produce more than 5% of the
Company's business and in total produce approximately 51.7% (1996: 44.8%; 1995:
66.6%). Approximately 21.3% (1996: 25.5%; 1995: 40.9%) of all business written
was arranged by one broker and its affiliates.
(d) EMPLOYMENT CONTRACTS
The Company has entered into employment agreements with its executive
officers for periods up to September, 2000. These agreements provide for
compensation in the form of salary, annual bonus, options to purchase shares in
the Company and reimbursement of certain expenses.
(e) TRIDENT
The Company, Marsh & McLennan Risk Capital Corp., JP Morgan Capital Corp.,
and BYRNE & Sons l.p., have organized The Trident Partnership LP, to invest
principally in newly formed insurance and reinsurance ventures organized by
Trident. The Company has made a commitment to invest up to $18,700 in Trident.
At October 31, 1997 the Company has invested $5,680 (1996: $6,914).
12. LINES OF CREDIT
In 1997 the Company obtained multi-currency committed lines of credit provided
by a syndicate of nine major international banks led by the Chase Manhattan
Bank, N.A. which provides for unsecured borrowing up to an aggregate amount of
$200,000 subject to certain conditions. At October 31, 1997, none of these lines
of credit were used.
13. PENSION PLAN
Effective January 1993, the Company adopted a money accumulation pension plan
for all eligible employees. Under this plan, the Company contributes on a
monthly basis approximately 10% of a participant's base salary. Pension costs
amounted to $1,346 for the year ended October 31, 1997 (1996: $589; 1995: $282).
CONSOLIDATED FINANCIAL STATEMENTS
45
<PAGE> 33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
14. TAXATION
Under current Cayman Islands law, the Company is not required to pay any taxes
in the Cayman Islands on either income or capital gains. The Company has
received an undertaking that in the event of any such taxes the Company will be
exempted from Cayman Islands income or capital gains tax until the year 2013.
Under current Bermuda law, neither the Company, Mid Ocean Reinsurance, Holdings
nor Ridgewood, "the Bermuda corporations", are required to pay any taxes in
Bermuda on either income or capital gains. The Company and the Bermuda
corporations have received an undertaking from the Minister of Finance in
Bermuda that in the event of any such taxes being imposed, the Company and the
Bermuda corporations will be exempted from income or capital gains taxation
until the year 2016.
The Company does not consider itself to be engaged in trade or business in
the United States and accordingly does not expect to be subject to direct United
States income taxation. Profits of the London branch and the Brockbank Group are
subject to United Kingdom corporation taxes. Profits of the Singapore branch are
subject to Singapore corporation taxes. The German subsidiary is subject to
taxation in Germany.
Non US income tax expense is solely attributable to income from continuing
operations and consists of:
<TABLE>
<CAPTION>
1997 1996 1995
<S> <C> <C> <C>
Current $11,772 $4,478 $ --
Deferred -- -- --
------- ------ ------
$11,772 $4,478 $ --
</TABLE>
The effective tax rate on income from continuing operations differs from the
Statutory US Federal tax rate for the following reasons:
<TABLE>
<CAPTION>
1997 1996 1995
<S> <C> <C> <C>
Year ended October 31 35.0% 35.0% 35.0%
Increase (reduction) in income taxes resulting from:
Income not subject to US taxes (35.0%) (35.0%) (35.0%)
Foreign taxes 4.6% 2.1% 0%
------ ------ ------
4.6% 2.1% 0%
</TABLE>
Management considers the tax effects of temporary differences that give rise
to deferred tax assets and deferred tax liabilities at October 31, 1997, 1996
and 1995 to be insignificant and immaterial to the consolidated financial
statements.
1997 [LOGO] MID OCEAN LIMITED ANNUAL REPORT
<PAGE> 34
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
15. STATUTORY 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 Holdings which relies on dividends from its
direct and indirect subsidiaries. The payment of such dividends is restricted by
applicable law including Bermuda and United Kingdom insurance law and
regulations, including those promulgated by the Society of Lloyd's.
Under the Insurance Act 1978, amendments thereto and related regulations of
Bermuda, Mid Ocean Reinsurance is required to prepare statutory financial
statements and to file in Bermuda a statutory financial return. In April 1995,
the Insurance Amendment Act 1995 ("the 1995 Act") became effective. Under the
1995 Act, Mid Ocean Reinsurance is registered as a Class 4 insurer and is
required to maintain certain measures of solvency and liquidity during the year.
The statutory capital and surplus of Mid Ocean Reinsurance at October 31,
1997 was approximately $1,200,000 (1996: $1,000,000) and the minimum required
statutory capital and surplus was approximately $162,000 at October 31, 1997
(1996: $263,000). Currently there are no effective statutory restrictions on the
payment of dividends from retained earnings by Mid Ocean Reinsurance or the
Company as the minimum statutory capital and surplus is satisfied by share
capital and additional paid in capital.
Mid Ocean Reinsurance's London branch is subject to regulation in the United
Kingdom under the Insurance Companies Act 1982. Under this Act, Mid Ocean
Reinsurance is required to maintain a margin of solvency and prepare a global
return to the U.K. Department of Trade and Industry ("DTI") incorporating
financial statement data of Mid Ocean Reinsurance. These DTI regulations do not
restrict payment of dividends by Mid Ocean Reinsurance or the Company.
Mid Ocean Reinsurance's Singapore branch is subject to regulation by the
Monetary Authority of Singapore. This includes quarterly reporting and solvency
margins to be maintained. These regulations do not restrict payment of dividends
by Mid Ocean Reinsurance or the Company.
16. FOREIGN SALES AND OPERATIONS
Financial information relating to gross premiums written by geographic area is
as follows:
<TABLE>
<CAPTION>
YEARS ENDED
----------------------------------------------------------------------------------------
1997 1996 1995
------------------------ ------------------------ -------------------------
Premiums Percentage Premiums Percentage Premiums Percentage
Written Written Written
<S> <C> <C> <C> <C> <C> <C>
Worldwide $205,671 36.7% $250,450 44.2% $191,801 43.0%
United States 133,291 23.8 135,830 24.0 126,553 28.4
United Kingdom 122,480 21.8 85,330 15.1 37,920 8.5
Japan 15,699 2.8 19,452 3.4 23,882 5.4
Australasia 12,563 2.2 13,744 2.4 16,049 3.6
Other 70,801 12.7 61,481 10.9 49,614 11.1
---------------------------------------------------------------------------------------
$560,505 100.0% $566,287 100.0% $445,819 100.0%
---------------------------------------------------------------------------------------
</TABLE>
CONSOLIDATED FINANCIAL STATEMENTS
47
<PAGE> 35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Financial information relating to foreign operations is as follows:
<TABLE>
<CAPTION>
GROSS PREMIUMS WRITTEN 1997 1996 1995
<S> <C> <C> <C>
Bermuda $ 288,985 $ 377,963 $ 445,819
United Kingdom 264,472 188,324 --
Other 7,048 -- --
$ 560,505 $ 566,287 $ 445,819
NET INCOME
Bermuda $ 234,577 $ 211,039 $ 182,935
United Kingdom 14,707 605 --
Other (4,276) -- --
$ 245,008 $ 211,644 $ 182,935
TOTAL ASSETS
Bermuda $ 1,879,460 $ 1,767,020 $ 1,655,508
United Kingdom 382,173 255,679 --
Other 8,972 -- --
$ 2,270,605 $ 2,022,699 $ 1,655,508
</TABLE>
17. EXCHANGE LOSS
Exchange gains and losses comprise the net effect of realized and unrealized
exchange gains and losses relating to the underwriting activities of the
Company. The unrealized component arises from the revaluation of certain foreign
currency assets and liabilities at the year end. The realized component arises
from the difference between amounts previously recorded for foreign currency
assets and liabilities and actual amounts received or paid during the year. The
exchange gains and losses are as follows:
<TABLE>
<CAPTION>
1997 1996 1995
<S> <C> <C> <C>
Realized (loss) gain $ (2,877) $ (3,599) $ (868)
Unrealized (loss) gain (7,127) 2,002 (1,568)
$(10,004) $ (1,597) $ (2,436)
</TABLE>
1997 [LOGO] MID OCEAN LIMITED ANNUAL REPORT
<PAGE> 36
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
18. DIVIDENDS
Dividends declared amounted to $3.00, $1.35 and $0.75 per ordinary share for
fiscal 1997, 1996 and 1995 respectively.
19. ADOPTION OF NEW ACCOUNTING STANDARDS
The Company has not adopted any new accounting standards during the year ended
October 31, 1997. The following are accounting standards issued which will have
an effect on the Company in the future. These standards are not expected to have
a material impact on the Company's financial position or results of operations.
The FASB issued SFAS No. 128 "Earnings per Share", effective for interim and
annual periods ending after December 15, 1997. This statement specifies revised
computation and disclosure requirements for earnings per share. It is not
expected to have a material impact on reported earnings per share.
The FASB issued SFAS No. 130 "Reporting Comprehensive Income" effective for
fiscal years beginning after December 15, 1997. This statement requires that
companies classify items of other comprehensive income by their nature in a
statement of financial performance and display the accumulated balance of other
comprehensive income separately from retained earnings and paid in capital in
the statements of shareholders' equity in the consolidated balance sheets.
The FASB issued SFAS No. 131 "Disclosures about Segments of an Enterprise and
Related Information" effective for periods beginning after December 15, 1997.
This statement requires that a company report financial and descriptive
information about its reportable operating segments.
CONSOLIDATED FINANCIAL STATEMENTS
49
<PAGE> 37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
20. UNAUDITED QUARTERLY FINANCIAL DATA
<TABLE>
<CAPTION>
1997
First Second Third Fourth
Quarter Quarter Quarter Quarter
<S> <C> <C> <C> <C>
Net premiums earned $ 108,077 $ 130,772 $ 128,047 $ 119,845
Net investment income 23,840 25,335 27,024 27,230
Net gains (losses) on investments 2,658 (3,387) 5,124 5,208
Other income (loss) (2,596) 4,712 9,082 8,400
Total revenues 131,979 157,432 169,277 160,683
Net losses and loss expenses incurred 51,438 57,011 59,427 48,295
Net income $ 52,002 $ 62,916 $ 65,512 $ 64,578
Net income per share $ 1.43 $ 1.65 $ 1.72 $ 1.65
</TABLE>
<TABLE>
<CAPTION>
1996
First Second Third Fourth
Quarter Quarter Quarter Quarter
<S> <C> <C> <C> <C>
Net premiums earned $ 102,106 $ 102,274 $ 114,102 $ 117,615
Net investment income 19,046 19,911 21,052 23,252
Net gains (losses) on investments 9,181 (1,986) (8,396) 3,327
Other income (loss) (1,380) 6,270 7,301 5,441
Total revenues 128,953 126,469 134,059 149,635
Net losses and loss expenses incurred 53,204 45,133 56,739 56,812
Net income $ 57,814 $ 50,972 $ 46,217 $ 56,641
Net income per share $ 1.57 $ 1.38 $ 1.26 $ 1.54
</TABLE>
1997 [LOGO] MID OCEAN LIMITED ANNUAL REPORT
<PAGE> 38
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders
Mid Ocean Limited
We have audited the accompanying consolidated balance sheets of Mid Ocean
Limited and subsidiaries as at October 31, 1997 and 1996 and the related
consolidated statements of operations, shareholders' equity and cash flows for
each of the years in the three year period ended October 31, 1997. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with United States generally accepted
auditing standards. Those standards require that we plan and perform an audit to
obtain reasonable assurance whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Mid Ocean Limited and subsidiaries as at October 31, 1997 and 1996 and the
results of their operations and their cash flows for each of the years in the
three year period ended October 31, 1997 in conformity with accounting
principles generally accepted in the United States of America.
[KPMG Peat Marwick]
Chartered Accountants
Hamilton, Bermuda
November 21, 1997
INDEPENDENT AUDITORS' REPORT
51
<PAGE> 1
Exhibit 21.1
MID OCEAN LIMITED
AND
SUBSIDIARIES
<TABLE>
<CAPTION>
% Beneficial Jurisdiction
Ownership by of
Immediate Parent Incorporation
---------------- -------------
<S> <C> <C>
Mid Ocean Limited -- Cayman Islands
Mid Ocean Holdings Ltd. 100 Bermuda
Mid Ocean Reinsurance Company Ltd. 100 Bermuda
Baltusrol Holdings Limited 51 Bermuda
Mid Ocean Reinsurance Consulting GmbH 100 Germany
Ridgewood Holdings Ltd. 100 Bermuda
The Brockbank Group plc 100 United Kingdom
Brockbank Holdings Limited 100 United Kingdom
Baltusrol Holdings Limited 49 Bermuda
Brockbank Underwriting Limited 100 United Kingdom
Brockbank Syndicate Management Limited 100 United Kingdom
Admiral Insurance Services Limited (1) 85.5 United Kingdom
Admiral Services (Europe) Limited 100 United Kingdom
Able Insurance Services Limited 100 United Kingdom
Brockbank Personal Lines Limited 100 United Kingdom
Zenith Policy Services Limited 100 United Kingdom
Cassidy Brockbank Limited 100 United Kingdom
Brockbank Insurance Services Ltd. 100 United Kingdom
Dornoch Limited 100 United Kingdom
County Down Limited 100 United Kingdom
</TABLE>
(1) Admiral Insurance Services Limited shares are held 80% by Brockbank
Syndicate Management Limited in trust on behalf of the syndicate names. 5.5%
are held directly by Brockbank Underwriting Limited.
<PAGE> 1
Exhibit 23.1
CONSENT OF INDEPENDENT AUDITORS
To the Board of Directors of
Mid Ocean Limited
We consent to the incorporation by reference in the registration statement (No.
33-78626) on Form S-8 and Form S-3 of Mid Ocean Limited of our report dated
November 21, 1997, relating to the consolidated balance sheets of Mid Ocean
Limited and subsidiaries as of October 31, 1997 and 1996 and the related
consolidated statements of operations, shareholders' equity and cash flows for
each of the years in the three year period ended October 31, 1997 and our report
dated November 21, 1997 on the schedules included in Form 10-K which reports
appear in the October 31, 1997 annual report on Form 10-K of Mid Ocean Limited
by reference.
KPMG Peat Marwick
Chartered Accountants
Hamilton, Bermuda
January 27, 1998
<PAGE> 1
EXHIBIT 99-1
CERTAIN TAX CONSIDERATIONS
The following summary of the taxation of the Company and Mid Ocean and the
material tax consequences of ownership of the Ordinary Shares to the
shareholders of the Company is based upon current law and is for general
information only. Legislative, judicial or administrative changes may be
forthcoming that could affect this summary. Statements made below as to Bermuda
law, Cayman Islands law and Untied States law represent, respectively, the
opinion of Conyers, Dill & Pearman, Bermuda counsel to the Company, Maples and
Calder, Cayman Islands counsel to the Company, and Cahill Gordon & Reindel,
United States counsel to the Company, as to the material tax consequences of
ownership of Ordinary Shares to a U.S. shareholder under the laws of such
jurisdictions.
TAXATION OF THE COMPANY AND MID OCEAN REINSURANCE CO LTD
Bermuda
The Company and Mid Ocean have each received from the Minister of Finance of
Bermuda an assurance under the Exempted Undertakings Tax Protection Act, 1966 of
Bermuda, to the effect that in the event of there being enacted in Bermuda any
legislation imposing tax computed on profits or income, or computed on any
capital asset, gain or appreciation, or any tax in the nature of estate duty or
inheritance tax, then the imposition of any such tax shall not be applicable to
the Company or Mid Ocean or to any of their operations or the shares, debentures
or other obligations of the Company or Mid Ocean, until 28th March, 2016. These
assurances are subject to the proviso that they are not construed so as to
prevent the application of any tax or duty to such persons as are ordinarily
resident in Bermuda (the Company and Mid Ocean are not currently so designated)
or to prevent the application of any tax payable in accordance with the
provisions of The Land Tax Act 1967 of Bermuda or otherwise payable in relation
to the land leased to Mid Ocean. Both the Company and Mid Ocean are required to
pay certain annual Bermuda government fees and Mid Ocean, additionally, is
required to pay certain insurance registration fees as an insurer under the
Insurance Act 1978 of Bermuda. Under current rates, the Company pays a fixed fee
of BD$1,600 and Mid Ocean pays a total of BD$9,000 per year (which includes the
annual Bermuda government fee and the annual insurance registration fee).
Currently there is no Bermuda withholding tax on dividends that may be paid by
Mid Ocean to the Company.
Cayman Islands
Under current Cayman Islands law, the Company is not obligated to pay any taxes
in the Cayman Islands on its income or gains. The Company has obtained from the
Governor-in-council of the Cayman Islands pursuant to the provisions of the Tax
Concessions Law, as amended, a 20 year Tax Exemption Certificate to the effect
that (I) no subsequently enacted law imposing any tax on profits, income, gains
or appreciations shall apply to the Company and (ii) no such tax and no tax in
the nature of an estate duty or an inheritance tax shall be payable on any
shares, debentures or other obligations of the Company. Under current law no tax
will be payable on the transfer or other disposition of the shares of the
Company. The Cayman Islands currently impose stamp duties on certain categories
of documents; however, the current
<PAGE> 2
operations of the Company do not involve the payment of stamp duties in any
material amount. The Cayman Islands currently impose an annual corporate fee
upon all exempted companies; at current rates the Company pays fees of
approximately $1,700 per annum.
United States
The Company and Mid Ocean believe that neither of them conducts a trade or
business within the United States and that, therefore, neither of them is
required to file United States income tax returns. However, the issue of whether
a foreign corporation is engaged in trade or business in the United States for
any fiscal year is a highly factual one, and, therefore, the Internal Revenue
Service generally will not rule on the issue. Definitive identification of
activities which constitute being engaged in a trade or business in the United
States is not provided by the Internal Revenue Code (the "Code") or regulations
or court decisions. Each of the Company and Mid Ocean intends not to engage in
any activity that would cause it to be engaged in trade or business for United
States federal income tax purposes. To that end, each of the Company and Mid
Ocean intend, among other actions, not to, directly or indirectly through
agents: maintain offices or own tangible property in the United States; perform
general corporate functions, such as maintenance of books and records and
communicating with and holding meetings of shareholders and directors, in the
United States; advertise or settle claims in the United States; or obtain
clients through U.S. insurance brokers.
There can be no assurance that the Internal Revenue Service ("IRS") will not
contend successfully that the Company or Mid Ocean is engaged in a trade or
business in the United States. A foreign corporation deemed to be so engaged in
a trade or business (1) would be subject to U.S. income tax, as well as the
branch profits tax, on its income which is treated as effectively connected with
the conduct of that trade or business unless the corporation is entitled to
relief under the permanent establishment provision of a tax treaty, as discussed
below, and (2) would be required to file yearly federal income tax returns.
Penalties may be assessed for failure to file tax returns. Such income tax, if
imposed, would be based on effectively connected income computed in a manner
generally analogous to that applied to the income of a domestic corporation,
except that a foreign corporation can anticipate an allowance of deductions and
credits only if it files a United States income tax return. Under regulations,
the foreign corporation would be entitled to deductions and credits for a
taxable year only if the return for that year is filed timely under rules set
forth therein. The federal tax rates currently are 34% for a corporation's
effectively connected income and 30% for the branch tax. An increase in the
corporate income tax rate to 36% for certain corporations has been proposed by
President Clinton, and an increase to 35% is reflected in tax bills (H.R. 2264
and S. 1134)which have been passed by the U.S. House of Representatives and
Senate. It is uncertain whether, or in what form, an increase in U.S. corporate
income tax rates may ultimately be enacted. The branch profits tax is imposed
each year on a corporation's effectively connected earnings and profits (with
certain adjustments) deemed repatriated out of the U.S.
Under the income tax treaty between Bermuda and the United States (the
"Treaty"), Mid Ocean is subject to U.S. income tax on any income found to be
effectively connected with a U.S. trade or business only if that
<PAGE> 3
trade or business is conducted through a permanent establishment in the United
States. No regulation interpreting the Treaty have been issued. While there can
be no assurances, the Company does not believe Mid Ocean has a permanent
establishment in the United States. Mid Ocean would not be entitled to the
benefits of the Treaty if (i) 50% or more of Mid Ocean's stock were beneficially
owned, directly or indirectly, by persons other than Bermuda residents or U.S.
citizens or residents, or (ii) Mid Ocean's income were used in substantial part
to make disproportionate distributions to, or to meet certain liabilities to,
persons who are not Bermuda residents or U.S. citizens or residents. While there
can be no assurances, the Company believes that no exception to Treaty benefits
will apply after the Offerings.
Foreign corporations not engaged in a trade or business in the United States are
nonetheless subject to U.S. income tax on certain "fixed or determinable annual
or periodic gains, profits and income" derived from sources within the United
States as enumerated in section 881la) of the Code (such as dividends and
certain interest on investments).
The United States also imposes an excise tax on insurance and reinsurance
premiums paid to foreign insurers or reinsurers with respect to risks located in
the United States. The rate of tax applicable to reinsurance premiums paid to
Mid Ocean is 1% of gross premiums. The Revenue Bill of 1992 (H.R. 11) as passed
by the U.S. Senate contained a provision which would have increased the excise
tax rate on reinsurance premiums paid to Mid Ocean to 4%. It is uncertain
whether, or in what form, a similar provision may ultimately be enacted.
TAXATION OF SHAREHOLDERS
Bermuda Taxation
There is no Bermuda withholding tax on dividends paid by the Company.
Cayman Islands Taxation
Dividends paid by the Company are not subject to Cayman Islands withholding tax.
United States Taxation of US. and Non-U.S. Shareholders
Classification of the Company or Mid Ocean as a Controlled Foreign Corporation.
Under section 951(a) of the Code, each "United States shareholder" of a
"controlled foreign corporation" ("CFC") must include in its gross income for
United States Federal income tax purposes its pro rata share of the CFC's
"subpart F income," even if the subpart F income is not distributed. Under Code
section 951(b), any U.S. corporation, citizen, resident or other U.S. person who
owns, directly or indirectly through foreign persons, or is considered to own
(by application of the rules of constructive ownership set forth in Code section
958(b), generally applying to options, family members, partnerships, estates,
trusts or controlled corporations), 10% or more of the total combined voting
power of all classes of stock of the foreign corporation will be considered to
be a "United States shareholder." In general, a foreign corporation is treated
as a CFC only if such "United States shareholders" collectively own more than
50% (more than 25% for certain insurance companies, such as Mid Ocean) of the
total combined voting power or total value of the corporation's
<PAGE> 4
stock for an uninterrupted period of 30 days or more during any tax year. Due to
the existence of extremely broad constructive ownership rules and for other
reasons it may be difficult or impossible for the Company to ensure that neither
it nor Mid Ocean has or will become a controlled foreign corporation. However,
so long as no shareholders of the Company or Mid Ocean are characterized as
United States shareholders, the classification of the Company or Mid Ocean as a
CFC should have no adverse effect on shareholders.
Therefore, each investor should consult its own tax advisor to ensure that its
ownership interest in the Company will not cause it to become a United States
shareholder of the Company, Mid Ocean or any subsidiary which may be created by
the Company or Mid Ocean.
Related Person Insurance Income Rules. Certain special provisions of the Code
will apply to Mid Ocean if both (A) as is anticipated, 25% or more of the value
or voting power of the Ordinary Shares is held (directly or indirectly through
foreign entities) by United States persons, and (B)(i) Mid Ocean has gross RPII
greater than or equal to 20% of its gross insurance income and (ii) 20% or more
of either the voting power or the value of the Mid Ocean common stock is owned
directly or indirectly through foreign entities by persons (directly or
indirectly) insured or reinsured by Mid Ocean or persons related to such
insureds or reinsureds. RPII is income (investment income and premium income)
from the direct or indirect insurance or reinsurance of any United States person
who holds Ordinary Shares (directly or indirectly through foreign entities) or a
person related to such a United States holder of Ordinary Shares.
While there can be no assurance, it is not anticipated that 20% or more of the
gross insurance income of Mid Ocean for any taxable year will constitute RPII.
If 20% or more of the gross insurance income of Mid Ocean for any taxable year
were to constitute RPII and 20% or more of the voting power or the value of Mid
Ocean's common stock were held by insureds or reinsureds or persons related
thereto, each direct and indirect United States holder of Ordinary Shares would
be taxable currently on its allocable share of the RPII. For this purpose, all
of Mid Ocean's RPII would be allocated solely to United States holders to the
extent of their ratable share of Mid Ocean's income.
Computation of RPII In order to determine how much RPII Mid Ocean has earned in
each fiscal year, the Company intends to obtain and rely upon information from
its insureds to determine whether any of Mid Ocean's insureds or persons related
to such insureds own shares of the Company and are U.S. persons. In addition,
the Company will send a letter after each fiscal year to each person who was a
Mid Ocean policyholder during the year asking the policyholder to represent
whether it was a U.S. shareholder of the Company or related to a U.S.
shareholder during the year. For any year in which Mid Ocean's gross RPII is 20%
or more of Mid Ocean's gross insurance income for the year, the Company may also
seek information from its shareholders as to whether beneficial owners of
Ordinary Shares at the end of the year are United States persons so that RPII
may be determined and apportioned among such persons. To the extent the Company
is unable to determine whether a beneficial owner of shares is a U.S. person the
Company may assume that such owner is not a U.S. person for purposes of
apportioning RPII, thereby increasing the per share RPII amount for all U.S.
shareholders.
<PAGE> 5
Dispositions of Ordinary Shares. Code section 1248 provides that if a U.S.
person owns directly or indirectly through foreign persons, or is considered to
own (by application of the rules of constructive ownership set forth in section
958(b) of the Code), 10% or more of the voting shares of a corporation that is a
CFC (such person being referred to as a "10% U.S. Shareholder"), any gain from
the sale or exchange of Ordinary Shares may be treated as ordinary income to the
extent of the CFC'S earnings and profits during the period that the shareholder
held the shares (with certain adjustments). A 10% U.S. Shareholder will be
required to report a disposition of shares of a CFC by attaching IRS Form 5471
to the U.S. income tax or information return that it would normally file for the
taxable year in which the disposition occurs. Code section 953(c)(7) generally
provides that section 1248 also will apply to the sale or exchange of shares in
a foreign corporation that earns RPII if the foreign corporation would be taxed
as an insurance company if it were a domestic corporation, regardless of whether
the shareholder is a 10% U.S Shareholder, RPII constitutes 20% or more of the
corporation's gross insurance income or 20% or more of either the voting power
or the value of the Mid Ocean common stock is owned directly or indirectly
through foreign entities by persons (directly or indirectly) insured or
reinsured by Mid Ocean or persons related to such insureds or reinsureds. RPII
is income (investment income and premium income) from the direct or indirect
insurance or reinsurance of any United States person who holds Ordinary Shares
(directly or indirectly through foreign entities) or a person related to such a
United States holder of Ordinary Shares. Although existing Treasury Department
regulations do not address the question, proposed Treasury regulations issued in
April, 1991 create some ambiguity as to whether Code section 1248 and the
requirement to file Form 5471 would apply when the foreign corporation (such as
the Company) is not a CI~C but the foreign corporation has a subsidiary that is
a CEC or that would be taxed as an insurance company if it were a domestic
corporation.
The Company believes, based on the advice of counsel, that Code section 1248 and
the requirement to file Form 5471 will not apply to dispositions of Ordinary
Shares because the Company does not have any 10% U.S. Shareholders and the
Company is not directly engaged in the insurance business and that the proposed
regu1ations issued by the U.S. Treasury Department in April, 1991 should be
interpreted in this manner. There can be no assurance, however, that the IRS
will interpret the regulations in this manner or that the Treasury Department
will not amend the regulations to provide that Code section IZ48 and the
requirement to file Form 5471 will apply to dispositions of Ordinary Shares. In
addition, U.S. persons who at any time own 5% or more of the shares of the
Company may have an independent obligation to file certain information returns.
If the IRS or Treasury Department were to make section IZ48 and the Form 5471
filing requirement applicable to the sale of Ordinary Shares, the Company would
notify shareholders that Code section IZ48 and the requirement to file Form 5471
will apply to dispositions of Ordinary Shares. Thereafter, the Company will send
a notice after the end of each calendar year to all persons who were
shareholders during the year notifying them that Code section 1248 and the
requirement to file Form 5471 apply to dispositions of Ordinary Shares. The
Company will attach to this notice a copy of Form 5471 completed with all
Company
<PAGE> 6
information and instructions for completing the shareholder information.
Uncertainty as to Application of RPII. The RPII provisions of the Code have
never been interpreted by the courts. Regulations interpreting the RPII
provisions of the Code exist only in proposed form, having been proposed in
April, 1991. It is not certain whether these regulations will be adopted in
their proposed form or what changes or clarifications might ultimately be made
thereto or whether any such changes, as well as any interpretation or
application of RPII by the IRS the courts or otherwise, might have retroactive
effect. The description of RPII herein is therefore qualified. Accordingly, the
meaning of the RPII provisions and the application thereof to the Company and
Mid Ocean are uncertain. These provisions include the grant of authority to the
U.S. Treasury to prescribe "such regulations as may be necessary to carry out
the purposes of this subsection including . . . regulations preventing the
avoidance of this subsection, through cross insurance arrangements or otherwise
.... " In addition, there can be no assurance that the amounts of the RPII
inclusions, if any, will not be subject to adjustment based upon subsequent IRS
examination. Each U.S. person who is considering an investment in the Ordinary
Shares should consult its tax advisor as to the effects of these uncertainties.
Foreign Tax Credit. In the event, as expected, that U.S. shareholders own at
least 50% of the Company's shares, only a portion of the dividends paid by the
Company will be treated as foreign source income for purposes of computing a
shareholder's U.S. foreign tax credit limitation. It is likely that
substantially all of the RPII and dividends that are foreign source income will
constitute either "passive" or "financial services" income for foreign tax
credit limitation purposes. Thus, it may not be possible for most U.S.
shareholders to utilize excess foreign tax credits to reduce U.S. tax on such
income.
Passive Foreign Investment Companies. Sections 1291 through 1297 of the Code
contain special rules applicable with respect to foreign corporations that are
"passive foreign investment companies" ("PFICs"). In general, a foreign
corporation will be a PFIC if 75% or more of its income constitutes "passive
income" or 50% or more of its assets produce passive income. If the Company were
to be characterized as a PFIC, its United States shareholders would be subject
to a penalty tax at the time of their sale of (or receipt of an "excess
distribution" with respect to) its shares. In general, a shareholder receives an
"excess distribution" if the amount of the distribution is more than 125% of the
average distribution with respect to the stock during the three preceding
taxable years (or shorter period during which the taxpayer held the stock). In
general, the penalty tax is equivalent to an interest charge on taxes that are
deemed due during the period the United States shareholder owned the shares,
computed by assuming that the excess distribution or gain (in the case of a
sale) with respect to the shares was taxed in equal portions throughout the
holder's period of ownership. The interest charge is equal to the applicable
rate imposed on underpayments of U.S. Federal income tax for such period.
The PFIC statutory provisions contain an express exception for income "derived
in the active conduct of am insurance business by a
<PAGE> 7
corporation which is predominantly engaged in an insurance business ...." This
exception is intended to ensure that income derived by a bona fide insurance
company is not treated as passive income, except to the extent such income is
attributable to financial reserves in excess of the reasonable needs of the
insurance business. In the Company's view, the Company and Mid Ocean, taken
together, are predominantly engaged in an insurance business and do not have
financial reserves in excess of the reasonable needs of their insurance
business. The PFIC statutory provisions contain a look-through rule that states
that, for purposes of determining whether a foreign corporation is a PFIC, such
foreign corporation shall be treated as if it "received directly its
proportionate share of the income" and as if it "held its proportionate share of
the assets" of any other corporation in which it owns at least 25% of the stock.
While no explicit guidance is provided by the statutory language, the Company
believes that under the look-through rule the Company would be deemed to own the
assets and to have received the income of Mid Ocean directly for the purposes of
determining whether the Company qualifies for the aforementioned insurance
exception. The Company believes, based upon the advice of counsel, that its
interpretation of the look-through rule is consistent with the legislative
intention generally to exclude bona fide insurance companies from the
application of PFIC provisions; there can, of course, be no assurance as to what
positions the IRS or a court might take in the future.
No regulations interpreting these specific issues under the PFIC provisions have
yet been issued. Therefore, substantial uncertainty exists with respect to their
application or their possible retroactivity. Each U.S. person who is considering
an investment in the Ordinary Shares should consult its tax advisor as to the
effects of these rules.
Other. Dividends paid by the Company to U.S. corporate shareholders will not be
eligible for the dividends received deduction provided by section 243 of the
Code.
Except as discussed below with respect to backup withholding, dividends paid by
the Company will not be subject to a U.S. withholding tax.
Nonresident alien individuals will not be subject to U.S. estate tax with
respect to Ordinary Shares of the Company.
Information reporting to the IRS by paying agents and custodians located in the
United States will be required with respect to payments of dividends on the
Ordinary Shares to U.S. persons. Thus, a holder of Ordinary Shares may be
subject to backup withholding at the rate of 31% with respect to dividends paid
by such persons, unless such holder (a) is a corporation or comes within certain
other exempt categories and, when required, demonstrates this fact; or (b)
provides a taxpayer identification number, certifies as to no loss of exemption
from backup withholding and otherwise complies with applicable requirements of
the backup withholding rules. The backup withholding tax is not an additional
tax and may be credited against a holder's regular Federal income tax liability.
<PAGE> 8
Subject to certain exceptions, persons that are not U.S. persons will be subject
to United States Federal income tax on dividend distributions with respect to,
and gain realized from the sale or exchange of, Ordinary Shares only if such
dividends or gains are effectively connected with the conduct of a trade or
business within the United States.
The opinions of Conyers Dill & Pearman, Maples and Calder and Cahill Gordon &
Reindel upon which the foregoing discussion is based do not include any factual
or accounting matters, determinations or conclusions such as RPII amounts and
computations and amounts of components thereof (e.g., amounts or computations of
income or expense items or reserves entering into RPII computations) or facts
relating to the Company's business or activities. The summary is based upon
current law and is for general information only. The tax treatment of a holder
of Ordinary Shares, or of a person treated as a holder of Ordinary Shares for
United States Federal income, state, local or non-U.S. tax purposes, may vary
depending on the holder's particular tax situation. Legislative, judicial or
administrative changes or interpretations may be forthcoming that could be
retroactive and could affect the tax consequences to holders of Ordinary Shares.
PROSPECTIVE INVESTORS SHOULD CONSULT THEIR OWN TAX ADVISORS CONCERNING THE
FEDERAL, STATE, LOCAL AND NON-U.S. TAX CONSEQUENCES OF OWNING THE ORDINARY
SHARES.
