10-K 1 d50060_10-k.txt ANNUAL REPORT UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED] For the fiscal year ended December 31, 2001. OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] For the transition period _________to_________ Commission file number 1-12823 LaSalle Re Holdings Limited (Exact Name of Registrant as Specified in Its Charter) Bermuda Not Applicable (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) Continental Building, 25 Church Street, Hamilton HM 12, Bermuda (Address of Principal Executive Offices) Registrant's Telephone Number, including area code: (441) 292-3339 Securities registered pursuant to Section 12(b) of the Act: Title of Each Class Name of Each Exchange on Which Registered Series A Preferred Shares, par value $1.00 per share The New York Stock Exchange, Inc.
Securities registered pursuant to Section 12(g) of the Act: None 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 this Form 10-K. [X] There was no voting stock held by non-affiliates on March 15, 2002. The number of shares outstanding of each of the issuer's classes of common stock as of March 15, 2002: Class Outstanding at March 15, 2002 Common Stock, $1.00 par value 20,432,043 LASALLE RE HOLDINGS LIMITED TABLE OF CONTENTS
Item Page Number ---- ----------- PART I 1. BUSINESS................................................................................. 3 2. PROPERTIES............................................................................... 18 3. LEGAL PROCEEDINGS........................................................................ 18 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS...................................... 18 PART II 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS...................................................................... 18 6. SELECTED FINANCIAL DATA.................................................................. 19 7. MANAGEMENTS' DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION.................................................................. 20 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK................................ 31 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.............................................. 32 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE..... 32 PART III 10. DIRECTORS AND EXECUTIVE OFFICERS......................................................... 33 11. EXECUTIVE COMPENSATION................................................................... 33 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT............................................................................... 37 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS........................................... 38 PART IV 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K...................................................................................... 38
i PART I Unless the context otherwise requires, references herein to the "Company" include LaSalle Re Holdings Limited and its subsidiary, LaSalle Re Limited ("LaSalle Re"), and its subsidiaries LaSalle Re Corporate Capital Ltd. ("LaSalle Re Capital"), LaSalle Re (Services) Limited ("LaSalle Re Services") and LaSalle Re (Barbados) Ltd. ("LaSalle Re Barbados"). Note On Forward-Looking Statements In connection with the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995, the Company sets forth below cautionary statements identifying important risks and uncertainties that could cause its actual results to differ materially from those that might be projected, forecasted or estimated in its "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, made by or on behalf of the Company in this Annual Report on Form 10-K and in press releases, written statements or documents filed with the Securities and Exchange Commission, or in its communications and discussions with investors and analysts in the normal course of business through meetings, telephone calls and conference calls. Such statements may include, but are not limited to, projections of premium revenue, investment income, other revenue, losses, expenses, earnings, cash flows, plans for future operations, common shareholders' equity (including book value per share), investments, financing needs, capital plans, dividends, plans relating to products or services of the Company and estimates concerning the effects of litigation or other disputes, as well as assumptions for any of the foregoing and generally expressed with words such as "believes", "estimates", "expects", "anticipates", "plans", "projects", "forecasts", "goals", "could have", "may have", and similar expressions. Forward-looking statements involve known and unknown risks and uncertainties, which may cause the Company's results to differ materially from such forward-looking statements. These risks and uncertainties include, but are not limited to, the following: - Changes in the level of competition in the United States and international reinsurance or primary insurance markets that affect the volume or profitability of the Company's property/casualty business. These changes include, but are not limited to, changes in the intensity of price competition, the entry of new competitors, existing competitors exiting the market and the development of new products by new and existing competitors; - Changes in the demand for reinsurance, including changes in ceding companies' risk retentions and changes in the demand for excess and surplus lines insurance coverages; - Changes in reinsurance purchasing and distribution patterns; - The ability of the Company to execute its strategies in its property/casualty operations; - Catastrophe losses in the Company's United States and international property/casualty businesses; - Adverse development on property/casualty claims and claims expense liabilities related to business written in prior years, including, but not limited to, evolving case law and its effect on environmental and other latent injury claims, changing government regulations, newly identified toxins, newly reported claims, new theories of liability or new insurance and reinsurance contract interpretations; - Changes in inflation that affect the profitability of the Company's current property/casualty business or the adequacy of its property/casualty claims and claims expense liabilities related to prior years' business; 1 - Lower than estimated retrocessional or reinsurance recoveries on unpaid losses, including, but not limited to, losses due to a decline in the creditworthiness of the Company's retrocessionaires or reinsurers; - Changes in the Company's retrocessional arrangements; - Increases in interest rates, which may cause a reduction in the market value of the Company's fixed income portfolio, and its common shareholders' equity; - Decreases in interest rates which may cause a reduction of income earned on cash flow from operations and the reinvestment of the proceeds from sales or maturities of existing investments; - Changes in the composition of the Company's investment portfolio; - Credit losses on the Company's investment portfolio; - Adverse results in litigation matters; - The passage of federal or state legislation subjecting the Company to United States taxation or regulation; - A contention by the United States Internal Revenue Service that the Company is subject to United States taxation; - The impact of mergers and acquisitions; - Gains or losses related to changes in foreign currency exchange rates; - Changes in the Company's capital needs; - The ability of Trenwick Group Ltd. to refinance or repay its outstanding indebtedness; and - Changes in the financial strength ratings. In addition to the factors outlined above that are directly related to the Company's businesses, the Company is also subject to general business risks, including, but not limited to, adverse legislation and regulation, adverse publicity or news coverage, changes in general economic factors and the loss of key employees. The facts set forth above should be considered in connection with any forward-looking statement contained in this Annual Report on Form 10-K. The important factors that could affect such forward-looking statements are subject to change, and the Company does not intend to update any forward-looking statement or the foregoing list of important factors. By this cautionary note the Company intends to avail itself of the safe harbor from liability with respect of forward-looking statements provided by Section 27A and Section 21E referred to above. 2 ITEM 1. BUSINESS General development of the business The Company was incorporated in Bermuda in September 1995 to act as an investment holding company for LaSalle Re, which was incorporated in Bermuda in October 1993 and commenced operations on November 22, 1993. On September 27, 2000, the Company, LaSalle Re, Trenwick Group Ltd. ("Trenwick") and Trenwick Group Inc. completed a business combination. Under the terms of the business combination, the common shareholders of the Company, LaSalle Re and Trenwick Group Inc. exchanged their shares on a one-for-one basis for shares in Trenwick. Following this transaction, the Company became a wholly owned subsidiary of Trenwick. In connection with the Trenwick/LaSalle business combination, the Company changed its year end from September 30 to December 31 to be consistent with Trenwick. Consequently, the data presented in the Form 10-K is for the twelve months ended December 31, 2001, the twelve months ended December 31, 2000, the three months ended December 31, 1999 and the twelve months ended September 30, 1999. Trenwick is the Bermuda holding company which, including the Company, has five principal operating units. Trenwick America Reinsurance Corporation provides reinsurance to U.S. insurance companies for property and casualty risks. Trenwick International Limited underwrites facultative reinsurance and specialty insurance on a worldwide basis. Canterbury Financial Group Inc. underwrites specialty property and casualty primary insurance programs through managing general agents. Chartwell Managing Agents Limited manages underwriting syndicates at Lloyds. LaSalle Re is a property and casualty reinsurer writing worldwide specialist products with an emphasis on catastrophe cover. Catastrophe reinsurance contracts cover unpredictable events such as hurricanes, windstorms, hailstorms, earthquakes, fires, industrial explosions, freezes, riots, floods and other man-made or natural disasters. It also seeks to take advantage of pricing opportunities that may occur in other lines of reinsurance. These lines currently include property risk excess, property pro rata treaty, casualty, marine, aviation, satellite, terrorism, and political risk coverages. LaSalle Re has three wholly owned subsidiaries: LaSalle Re Services (currently inactive), which acted as a representative office for the Company in the United Kingdom up until the completion of the Trenwick/LaSalle business combination, LaSalle Re Capital, which was incorporated in Bermuda in November 1996 to provide capital support to selected syndicates at Lloyd's; and LaSalle Re Barbados, which was incorporated in Barbados in 2001 and acts as an investment holding company. Business segments The Company writes property and casualty reinsurance on a worldwide basis through its operating subsidiary, LaSalle Re. The Company also writes selected other lines of reinsurance when it believes that market conditions are favorable. The Company has two reportable segments: reinsurance operations and Lloyd's syndicates. The reinsurance segment provides reinsurance for property catastrophe and for other lines of business that have similar characteristics, namely high severity and low frequency. These lines currently include property risk excess, property pro rata treaty, casualty, marine, aviation, satellite, terrorism multi-peril crop and political risk coverages. The Lloyd's syndicates' segment, currently in run-off was written through LaSalle Re Capital, which provided capital support to selected Lloyd's syndicates. The lines of business written by the selected syndicates included direct insurance and facultative property reinsurance, marine insurance and reinsurance, professional indemnity, directors and officers insurance and bankers blanket bond 3 business. Effective for the 2001 underwriting year at Lloyd's, LaSalle Re Capital withdrew its capital support from all Lloyd's syndicates. Complete financial information about segments is presented in Note 3 to the Company's consolidated financial statements. The following table sets forth the Company's gross premiums written and number of contracts written by business segment and type of reinsurance for the years ended December 31, 2001 and 2000, the three month period ended December 31, 1999 and the fiscal year ended September 30, 1999 (dollars in millions):
2001 Year 2000 Year 1999 Period 1999 Year Gross Number Gross Number Gross Number Gross Number Premiums of Premiums of Premiums of Premiums of Written Contracts Written Contracts Written Contracts Written Contracts ------- --------- ------- --------- ------- --------- ------- --------- Reinsurance segment: Property catastrophe reinsurance: Excess of loss................. $101.5 646 $78.1 661 $1.0 18 $ 81.4 717 Pro rata....................... 3.2 2 2.5 3 -- -- 11.1 8 Other lines of business: Property--risk excess and pro Rata........................... 8.9 43 6.4 53 0.5 2 4.9 62 Casualty....................... 2.0 20 2.2 17 0.2 1 6.1 26 Space, marine and aviation..... 3.6 8 3.8 24 5.4 31 Miscellaneous.................. 6.3 28 3.9 24 1.2 4 4.4 43 Fronted premiums, adjustments, reinstatement premiums and no claims bonuses................... 14.8 -- 4.7 -- 4.1 -- 3.3 -- ----- --- ----- --- --- --- ----- --- 140.3 747 101.6 782 7.0 25 116.6 887 ====== === ===== === === === ===== === Lloyd's segment: LaSalle Re Capital (in run-off) 5.2 28.6 3.3 22.4 ------ ------ ----- ------ Total..................... $145.5 $130.2 $10.3 $139.0 ====== ====== ===== ======
Property catastrophe The largest portion of the Company's business consists of property catastrophe excess of loss contracts. Property catastrophe excess of loss reinsurance provides coverage when total losses and loss expenses from a single occurrence of a covered peril under a portfolio of primary insurance contracts exceed the attachment point specified in the reinsurance contract with the primary insurer. Some of the Company's property catastrophe excess of loss policies limit coverage to one occurrence in a policy year, but most policies provide for coverage of a second occurrence after the payment of a reinstatement premium. The Company also writes a minimal amount of aggregate property catastrophe excess of loss contracts that cover an accumulation of catastrophes in a year rather than one occurrence. The Company writes a limited number of property catastrophe pro rata reinsurance treaties. In these programs, the Company assumes a specified proportion of the exposure under a portfolio of excess of loss property catastrophe reinsurance contracts written by the ceding reinsurer and receives an equal proportion of the premium received by the cedent. The cedent generally receives a ceding commission, based upon the premiums ceded to the reinsurer, and may also be entitled to receive a profit commission based on the ratio of losses, loss expenses and the reinsurer's expenses to premiums ceded. The Company generally requires that its property catastrophe pro rata contracts have aggregate exposure limits per occurrence on a zonal basis. The Company usually obtains detailed information concerning each underlying contract and the exposures underlying the risks it assumes and, on occasions may audit the premiums associated with the cessions. However, the Company is dependent upon the cedent's underwriting, pricing and claims administration to yield an underwriting profit. 4 Other lines of business The Company's property risk excess of loss contracts cover a cedent's loss on a single "risk" in excess of the cedent's attachment point, rather than covering multiple risks as does property catastrophe reinsurance. 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. In property pro rata reinsurance treaties, the Company assumes a proportional part of the original premiums and losses of the reinsured on its insurance and reinsurance contracts. In property pro rata reinsurance, the reinsurer generally pays the ceding company a ceding commission. The ceding commission generally is based on the ceding company's cost of acquiring the business being reinsured (including commissions, premium taxes, assessments and miscellaneous administrative expenses) and also may include a profit factor. In addition to property risk excess of loss and property pro rata treaties, the Company also writes other lines of reinsurance, which currently include casualty clash, marine, aviation, satellite, terrorism, multi-peril crop and political risk. The Company's underwriting strategy with respect to these lines of business is to target those lines which demonstrate relatively low historical levels of attritional loss. Excess of loss contracts are written above a significant attachment point and therefore should be impacted only by large market losses such as the destruction of an oil drilling platform (marine coverage) or an airline disaster (aviation coverage). Pro rata contracts, where the Company has proportional responsibility for the first dollar of its cedents' losses, could be impacted by the cedents' expected loss ratios as well as by large market losses. Claims on those contracts could arise from physical damage, casualty and major political and trade crises. Casualty clash excess of loss reinsurance protects cedents from losses that arise from multiple insureds or from one large severe event. The Company does not write casualty excess of loss business at a level where frequency of loss is anticipated. Marine and aviation coverages can be triggered by physical damage perils and may also entail casualty coverages arising from the same loss event. Satellite reinsurance protects the reinsured primarily for losses arising from launch failure and in-orbit breakdown. Terrorism reinsurance provides coverage against major terrorist incidents involving damage to property. Political risk includes coverages for losses arising from contract frustration, confiscation, repatriation and international trade credit transactions. Multi-peril crop includes coverage for agricultural losses associated with severe drought and floods. Fronting arrangements, adjustment premiums, reinstatement premiums and no claims bonuses Fronting is an arrangement whereby the Company issues a contract on a risk for, and at the request of, the insured with the intent of reinsuring the entire risk with another reinsurer. The risk assumed by the Company is primarily credit risk. During the year ended December 31, 2000, the Company provided fronting arrangements for three reinsurers. During 2001, this business was insignificant. Due to the changing nature of the Company's exposure under an excess of loss contract, certain contracts contain adjustable premium clauses. The Company receives an initial deposit premium or minimum deposit, with the final premium calculated at the end of the contract period using a pre-negotiated percentage of the ceding company's gross net annual premium income. The adjustment premium is equal to the difference between the initial deposit or minumum deposit and the revised premium. In addition, the Company receives adjustment premiums on its property catastrophe pro rata reinsurance treaties. The Company estimates premiums written using reports received from ceding companies adjusted for previous years' experiences of actual premiums against estimated premiums. These estimates are revised during the contract period as more information as to actual premiums written by the ceding companies is received. Any differences between the estimate and the revised information are recorded as adjustments during the period the revised information is received. 5 The Company typically receives and pays reinstatement premiums on its assumed and ceded contracts when a catastrophic event occurs that results in a loss. Coverage is reinstated over the remaining life of the contracts. As a result of the September 11th terrorist attacks, the Company received gross reinstatement premiums of $14.4 million and paid ceded reinstatement premiums of $19.3 million in 2001. The net decrease on net premiums earned due to reinstatement premiums for 2001 was $10.2 million. Some excess of loss contracts contain a no claims bonus clause. Where no claim is made under the contract, the ceding company is entitled to a pre-determined return premium, which is referred to as a "no claims bonus". A liability for the "no claims bonus" is established at the same time the gross written premium is recorded. If a loss occurs, the no claims bonus is reversed in the period in which the loss is reported to the Company. Lloyd's syndicates segment The Company formed LaSalle Re Capital to provide capital support on an underwriting year basis to selected Lloyd's syndicates. These syndicates individually write the following lines of business: direct insurance and facultative property reinsurance; marine insurance and reinsurance; and professional indemnity, directors and officers' insurance and bankers blanket bond business. Following the Trenwick/LaSalle business combination, the Company withdrew its capital support for the 2001 underwriting year. This decision is in line with the Company's strategy of returning to its core business of property catastrophe reinsurance. The Company has provided capital support to three syndicates for the 2000 and 1999 underwriting years of approximately $21.3 million ((pound)14.6 million) and $28.3 million ((pound)19.4 million), respectively. Through this support and as at December 31, 2001, the Company has written gross premiums of approximately $18.6 million for the 2000 underwriting year and approximately $32.9 million for the 1999 underwriting year. Capital support does not necessarily equate to premium income, due to different levels of capital utilization by the syndicates. LaSalle Re Capital provides capital support to the syndicates through letters of credit totaling $16.1 million ((pound)9.8 million). During the year ended December 31, 2001, the 1998 underwriting year on which LaSalle Re Capital participated was closed and settled. The net result from the 1998 underwriting year was a loss of $5.8 million to the Company. Geographic diversification The Company seeks to diversify its property catastrophe exposures across geographic zones in order to optimize its spread of risk. For the year ended December 31, 2001, excluding the premiums written by LaSalle Re Capital, fronted premiums, adjustment premiums, reinstatement premiums and no claims bonuses, 50% of the Company's gross premiums written represented U.S.-based risks. Within the United States, the Company's largest exposure on a zonal basis is the West Coast, including Hawaii and Alaska. The remaining 50% of gross premiums written was spread in other territories around the world. This distribution of risk is subject to change and is dependent upon rates available in various zones. As a result of long-term relationships between the Company's management and certain clients and brokers, the Company has developed a strong base of regional business in the U.S. This business assists the Company in diversifying its U.S.-based risks and makes more efficient use of its capital by limiting multi-zone exposures. 6 The following table sets forth the percentage of the Company's gross premiums written for the years ended December 31, 2001 and 2000, the three month period ended December 31, 1999 and the fiscal year ended September 30, 1999 allocated to the geographic region in which the risks originate: (dollars in millions):
Geographic Area 2001 Year 2000 Year 1999 Period 1999 Year Percentage Percentage Percentage Percentage Gross of Gross Gross of Gross Gross of Gross Gross of Gross Premiums Premiums Premiums Premiums Premiums Premiums Premiums Premiums Written Written Written Written Written Written Written Written ------- ------- ------- ------- ------- ------- ------- ------- United States................... $62.4 49.7% $ 51.4 53.0% $ 0.7 24.1% $ 60.1 53.0% Europe (excluding the U.K.)..................... 10.8 8.6 4.8 5.0 -- -- 9.5 8.4 United Kingdom.................. 9.1 7.3 7.0 7.2 0.1 3.5 9.8 8.6 Japan........................... 10.7 8.5 4.9 5.1 0.4 13.8 2.9 2.6 Australasia..................... 5.9 4.7 3.0 3.1 0.2 6.9 4.5 4.0 Worldwide(1).................... 17.0 13.6 16.8 17.3 1.2 41.4 14.1 12.4 Worldwide (excluding the U.S.)(2).................. 2.9 2.3 2.9 3.0 -- -- 5.4 4.8 Other........................... 6.7 5.3 6.1 6.3 0.3 10.3 7.0 6.2 ----- ----- ------ ----- --- ----- ----- ----- 125.5 100.0% 96.9 100.0% 2.9 100.0% 113.3 100.0% ===== ===== ===== ===== LaSalle Re Capital.............. 5.2 28.6 3.3 22.4 Fronted premiums, adjustments, reinstatement premiums and no claims bonuses............. 14.8 4.7 4.1 3.3 ------ ------ ----- ------ Total...................... $145.5 $130.2 $10.3 $139.0 ====== ====== ===== ======
(1) The category "Worldwide" consists of contracts that cover more than one zone, at least one of which is in the U.S. (2) The category "Worldwide (excluding the U.S.)" consists of contracts that cover more than one zone (none of which is in the U.S.). The exposure in this category for business written to date is predominantly from Europe and Japan. Program limits Property catastrophe reinsurance is usually arranged in a series of layers, which form an individual program. The Company may write one or more of these layers with each layer constituting a separate contract. The following table sets forth the number of the Company's property catastrophe excess of loss programs written in the year ended December 31, 2001 by aggregation of program limits: 2001 Year ----------- Greater than $25 million........................ 2 $20-25 million.................................. 1 $15-20 million.................................. 13 $10-15 million.................................. 20 $7.5-10 million................................. 23 $5-7.5 million.................................. 40 $2.5-5 million.................................. 76 Less than $2.5 million.......................... 84 --- Total...................................... 259 === 7 Underwriting The Company's principal underwriting strategy is to underwrite property catastrophe exposures within clearly defined parameters that permit thorough analysis and appropriate pricing of each of the Company's reinsurance contracts. In many cases, this includes analysis of a reinsurance contract based on the expected incremental return on equity in relation to the Company's overall portfolio of reinsurance contracts. The Company sets limits on its aggregate loss exposure and uses various methods to evaluate and monitor its exposure to loss. The Company diversifies its property catastrophe exposures worldwide and within each geographic zone and also maintains exposure limits within each geographic zone. Aggregate exposures also are controlled and monitored on a real-time basis using computer-based rating and control systems. The Company participates at attachment levels that are expected to exceed normal loss frequency. In addition, the Company regularly re-evaluates its pricing to ensure that the terms and conditions of its business are competitive within the market. The Company obtains information from brokers, cedents and potential cedents as well as other sources, as appropriate, in order to make informed underwriting decisions. A potential cedent generally is not accepted without a thorough examination of its historical record, management, overall financial condition, business strategy, underwriting policies and risk management systems. The Company also seeks to select clients with disciplined catastrophe management programs. The Company seeks to build long-term relationships with its clients because the Company believes that it can underwrite renewal business with greater precision. The Company uses proprietary modeling systems as well as commercially available catastrophe simulation models to estimate exposure to loss and evaluate the pricing adequacy of its reinsurance programs. These models also assist in the monitoring of aggregate exposures within geographic zones. The commercially available models include: (1) AIR-CATRADER 3.8, which uses market share data derived from zip code and/or county aggregate data to develop individual contract and portfolio loss scenarios and (2) RMS-Risklink 4.1, which derives portfolio loss scenarios based on detailed risk location data provided by the primary insurer. The results of all analyses are measured against the Company's current portfolio and other available external market information; and it is combined with management's knowledge of the client and the current reinsurance market environment. Pricing and participation decisions are then made based on the estimated exposure of losses and the potential impact of each contract on marginal return on equity. In addition, the underwriting of all new exposures is reviewed by the Chief Underwriting Officer and/or the President of the Company. On October 1, 1998 the Company entered into an Underwriting Support Services Agreement with CNA Re Services Company ("CRSC") and CNA Bermuda. Under the Underwriting Support Services Agreement, which expired on September 30, 2001, CRSC provided underwriting support services to the Company on a daily or hourly fee basis when and as requested by the Company. Between the closing of the Trenwick/LaSalle business combination and September 30, 2001, the Company did not use the support services provided under the Underwriting Support Services Agreement. Reinsurance protections purchased The Company utilizes various reinsurance protections to reduce its exposure to large losses. The Company reviews the claims paying ability of each reinsurer for adequacy before each cover is placed. In 2001, the Company has purchased three excess of loss programs which provide coverage of $20.0 million in excess of the first $30.0 million of losses per occurrence, $5.0 million in excess of the first $50.0 million of losses per occurrence and $25.0 million in excess of the first $75.0 million of losses per occurrence. 8 During 1999, the Company purchased an excess of loss program which provided coverage of $75.0 million in excess of the first $75.0 million of losses per occurrence for a first loss event and $60.0 million excess of $75.0 million per occurrence on the second loss event and $52.5 million excess of $125.0 million per occurrence on the third loss event over a three-year period ended December 31, 2001 subject to a maximum aggregate recovery of $187.5 million. This contract was canceled effective December 31, 2000. In addition, in 1999 and 2000, the Company had a quota share arrangement with CNA. This arrangement was canceled effective December 31, 2000. Under this arrangement, the Company ceded an adjustable proportion of U.S. property catastrophe premium, net of acquisition costs, which was negotiated on normal commercial terms and included an override commission and profit commission payable to the Company. The Company has also purchased other non-proportional excess of loss protections, which provide for the recovery of losses from reinsurers in excess of certain retentions that are related to the magnitude of market losses. LaSalle Re Capital also participates in the reinsurance coverages purchased by the syndicates it supports. In addition, as part of the Company's capital protection strategy, the Company utilized a Catastrophe Equity Put ("CatEPut") option program since July 1, 1997. The CatEPut option was a capital replacement tool that enabled the Company to put a pre-arranged amount of equity, through the issue of convertible preferred shares to the option writers at pre-negotiated terms, in the event of a major catastrophe or series of large catastrophes that cause substantial losses to the Company or its subsidiaries. After the Trenwick/LaSalle business combination, although the CatEPut remained in effect with the same triggers, the issuer of the convertible preferred shares changed from LaSalle to the publicly traded Trenwick. Accordingly, although the CatEPut will be triggered by loss experience at the Company, the capital will be received by Trenwick. Marketing The Company markets its reinsurance products worldwide primarily through reinsurance brokers. By marketing its products primarily through the broker network, the Company limits the expense of establishing and maintaining worldwide offices and marketing operations. The Company believes that its broker relationships permit it to obtain business and monitor developments in various lines of reinsurance in order to increase its writings when market conditions in those lines are favorable. The Company strives to develop strong relationships with its brokers and clients. Retention of clients permits the Company to use experience regarding a client's underwriting practices and risk management systems to underwrite its own business with greater precision. The Company targets brokers and clients that it believes will enhance the risk/return composition of its portfolio, are capable of supplying detailed and accurate underwriting data and can potentially add diversification to the Company's book of business. In addition, the Company meets frequently in Bermuda and elsewhere outside of the United States with brokers and senior representatives of clients and prospective clients. The Company focuses on providing high quality service by promptly responding to underwriting submissions, designing customized programs and offering lead terms when circumstances warrant and paying valid claims within an average of five days. The Company believes that it has established a reputation with its brokers and clients for high quality service. Additionally, the Company believes that its level of capital and surplus offers financial security and demonstrates to brokers and clients a high level of commitment to property catastrophe reinsurance. 9 Subsidiaries and affiliates of Aon Corporation (collectively, "Aon") were brokers for 26.7% and 23.3% of the Company's gross written premiums in the years ended December 31, 2001 and December 31, 2000 respectively. Guy Carpenter & Company, Inc., together with its affiliates, generated 26.1% and 19.8% of the Company's gross premiums written for the years ended December 31, 2001 and December 31, 2000 respectively. Willis Faber North America, Inc., together with its affiliates, generated 10.7% and 5.4% of the Company's gross premiums written for the years ended December 31, 2001 and December 31, 2000, respectively. No other broker accounted for more than 10% of the Company's gross premiums written for the years ended December 31, 2001 and December 31, 2000. Consistent with its emphasis on disciplined underwriting practices, the Company was not obligated to accept any business from any broker. No intermediary has the authority to bind the Company on any business. Reserves The Company establishes loss reserves for the estimated ultimate settlement costs of all losses and loss expenses incurred with respect to business written by it. United States generally accepted accounting principles, sometimes referred to as U.S. GAAP do not permit the Company to establish reserves with respect to its property catastrophe reinsurance until an event occurs that may give rise to a claim. As a result, only loss reserves applicable to losses incurred up to the reporting date may be set aside, with no allowance for the provision of a contingency reserve to account for expected future losses. The derivation of loss reserves involves the actuarial and statistical projection at any given time of the Company's expectations of the ultimate settlement of loss and loss expenses. These loss projections become necessary, primarily, as a result of time lags associated with reinsurance loss reporting. These lags are principally attributable both to claimant delays in reporting to the primary carrier as well as primary and reinsurance company delays in gathering statistics and subsequently reporting cession details to the Company. As a result, in addition to the loss estimates reported by primary insurers on known claims, actuarially projected estimates of reserves applicable to both the development (growth) of known claims as well as the emergence of new claims reports related to loss events which have been incurred but not reported ("IBNR losses") prior to the evaluation date must be developed. In addition to the impact of reporting lags upon the accuracy of estimated loss liabilities, other factors have significant impact upon the ultimate settlement of insured losses, including loss cost inflation, trends in the amount of insurance purchased to the full value of insured properties and trends in the size and demographics of insured populations. Loss reserve estimates are not precise in that they necessarily involve an attempt to predict the ultimate outcome of future loss reporting and settlement activities. To establish appropriate loss reserves, the Company uses a combination of data sources and commercially available catastrophe models. These models are employed upon the occurrence of an event to arrive at estimates of losses to the Company. In addition, grouped and individual contract data illustrating the loss development history for prior similar events, as well as actual loss emergence experience of the underlying insurers, are analyzed to assist in the determination of suitable loss reserves. The data derived from the industry sources, and supplemented with the client specific information, are then used to arrive at estimates of loss emergence patterns and initial estimates of ultimate loss ratios. These parameters are then applied, on a contract-by-contract basis, to arrive at estimates of ultimate losses. These loss estimates are then supplemented with the results derived from the catastrophe models, and final loss estimates are selected and reduced for losses reported to the Company to arrive at IBNR losses as of the date of evaluation. The reserves for LaSalle Re Capital are separately derived primarily from an analysis using expected loss ratios which is supplemented, when available, by actuarial evaluations produced for the individual syndicates. 10 To establish appropriate loss reserves, the Company uses both proprietary and commercially available catastrophe models. These models are employed upon the occurrence of an event to arrive at an estimate of losses to the Company as a result of the event. Where loss reports have been received from ceding companies, these reports are used in conjunction with the results produced from the catastrophe models to determine the appropriate loss reserves for an event. In addition, loss emergence patterns and initial estimates of ultimate loss ratios which are derived from a combination of data sources, including industry sources and the Company's own loss experience and exposure, are applied to homogenously grouped data to determine estimates of ultimate losses and hence suitable loss reserves for these groups. The reserves are prepared quarterly by the Chief Actuary of Trenwick and reviewed by the Company's executive officers. To the extent that reserves develop upward or downward, the results are reflected in the net income in the period in which the reserve deficiency or redundancy is evaluated. There can be no assurance that the final loss settlements will not exceed the Company's loss reserve and have a material adverse effect upon the Company's financial condition and results of operations in a particular period. Investments Composition of portfolio The Company has implemented a set of investment guidelines designed to meet its liquidity requirements and return objectives. The guidelines are intended to be conservative, stressing preservation of principal, yield enhancement through the identification of value and market inefficiencies, market liquidity and risk reduction. The primary objective of the investment portfolio, as set forth in the guidelines, is to maximize investment returns consistent with these policies. The Company's portfolio includes two sections: a shareholder portfolio and a reserve portfolio. The shareholder portfolio has a longer time horizon than the reserve portfolio. Quality of portfolio The Company's investment guidelines requires the securities held in the shareholder portfolio and the reserve portfolio to maintain an average quality of A+ and AA, respectively. In addition, the shareholder portfolio and the reserve portfolio will not invest in securities below A- and BB+, respectively. Maturity and duration of portfolio The Company's investment guidelines specify a one to four year duration for the Company's investment portfolio, reflecting the need to maintain a liquid, short duration portfolio to assure the Company's ability to pay claims on a timely basis. The Company currently has a target duration for the portfolio of two and one half to three years and, at December 31, 2001, the modified average duration of the portfolio was 2.7 years. The Company expects to periodically re-evaluate the target duration in light of market conditions, including the level of interest rates, and estimates of the duration of its liabilities. 11 The table below sets forth the distribution of the Company's debt securities available for sale at year end 2001 by type, maturity and quality rating. Debt Security Investments (Amounts expressed in thousands of United States dollars)
Average Maturity Fair Amortized in Years Value Cost ----------------- --------------- ------------- Type U.S. and U.K. federal government securities, including agencies 2.2 54,869 52,803 Other foreign government securities 1.0 25,186 24,448 Mortgage and other asset-backed securities 2.8 119,411 117,991 Corporate and other debt securities 6.0 307,812 307,232 ----------------- --------------- ------------- Total debt securities 4.4 507,278 502,474 Maturity Due in one year or less 74,539 73,125 Due in one year through five years 301,211 292,821 Due in five years through ten years 74,569 74,416 Due after ten years 56,959 62,112 --------------- ------------- Total debt securities 507,278 502,474
Investment Grade Non-investment Grade -------------------------- -------------------------- Quality Fair Value Cost Fair Value Cost ------------ ---------- ------------ ----------- U.S. and U.K. federal government securities, including agencies $ 54,869 $ 52,803 $ -- $ -- Other foreign government securities 25,186 24,448 -- -- Mortgage and other asset-backed securities 119,411 117,991 -- -- Corporate and other debt securities 274,914 268,841 32,898 38,391 --------- --------- --------- --------- Total investment grade and non-investment grade debt securities $474,380 $464,083 $32,898 $38,391 ========= ========= ========= ========= Percentage of total debt securities 93.5% 92.4% 6.5% 7.6% Investment Grade Quality (fair value) Aaa Aaa A Baa --------- --------- --------- --------- U.S. and U.K. federal government securities, including agencies $ 54,869 $ -- $ -- $ -- Other foreign government securities -- $25,186 -- -- Mortgage and other asset-backed securities 119,411 -- -- -- Corporate and other debt securities 95,888 63,000 83,048 32,978 --------- --------- --------- --------- Total investment grade and non-investment grade debt securities $270,168 $88,186 $83,048 $32,978 ========= ========= ========= ========= Percentage of total debt securities 53.2% 17.4% 16.4% 6.5% Non-investment Grade Quality (fair value) Ba/B Caa/Ca P1 Not rated --------- --------- --------- --------- Mortgage and other asset-backed securities $ -- $ -- $ -- $ -- Corporate and other debt securities 32,898 -- -- -- --------- --------- --------- --------- Total non-investment grade debt securities $32,898 $ -- $ -- $ -- ========= ========= ========= ========= Percentage of total debt securities 6.5% 0.0% 0.0% 0.0%
12 Equity securities/Real estate Pursuant to the Company's investment guidelines, the Company's investment portfolio may not contain any direct investments in real estate, mortgage loans or equity securities. Foreign currency exposures As at December 31, 2001, all of the Company's debt securities were denominated in U.S. dollars. In an effort to manage other areas of exposure to foreign currency exchange rate fluctuations, the Company may from time to time enter into foreign exchange contracts. These contracts generally involve the exchange of one currency for U.S. dollars at some future date. At December 31, 2001 and 2000, the Company had no principal amounts outstanding under foreign exchange contracts. See "Quantitative and Qualitative Disclosure About Market Risk." Investment manager Effective January 1, 2001, the Company appointed Wellington Management Company LLP to act as its investment manager. Prior to this, LaSalle Re had an investment management agreement with Aon Advisors (UK) Limited which terminated December 31, 2000. Competition The property catastrophe reinsurance industry is highly competitive. The Company competes, and will continue to compete, with major U.S. and non-U.S. insurers and property catastrophe reinsurers, including other existing and newly formed Bermuda-based property catastrophe reinsurers. Some of these competitors have greater financial and organizational resources than the Company. A recent trend in the property catastrophe reinsurance industry has been the utilization of the capital markets in structuring reinsurance agreements using catastrophe bonds, swaps and other types of derivative instruments. There may be established or new companies of which the Company is not aware who may be planning to enter the property catastrophe reinsurance market or existing reinsurers who may be planning to raise additional capital. Competition in the types of reinsurance business that the Company underwrites is based on many factors, including rates and other terms and conditions offered, services provided, ratings assigned by independent rating agencies, speed of claims payment and reputation, the perceived financial strength and experience of the reinsurer in the line of reinsurance to be written. LaSalle Re currently has a rating of "A-" (Excellent) from A.M. Best Company and is assigned "A-" financial strength rating by Standard & Poor's. These ratings are based on factors of interest to cedents and brokers and are not directed toward the protection of investors. These ratings are neither a rating of securities nor a recommendation to buy, hold or sell such securities. Insurance ratings are one factor used by brokers and cedents as a means of assessing the financial strength and quality of reinsurers. In addition, a cedent's own rating may be adversely affected by the lack of a rating of its reinsurer. Therefore, a cedent may elect to reinsure with a competitor of the Company that has a higher insurance rating. Similarly, the lowering or loss of a rating in the future could adversely affect the Company's ability to compete. Other than being a corporate member of selected Lloyd's syndicates, the Company is not licensed or admitted as an insurer in any jurisdiction other than Bermuda and has no plans to become so licensed or admitted. Because jurisdictions in the United States do not permit insurance companies to take credit for reinsurance obtained from unlicensed or non-admitted insurers on their statutory financial statements unless security is posted, the Company's reinsurance contracts generally require it to post a letter of credit or provide other security for outstanding claims and/or unearned premiums. In order to post these letters of credit, the Company 13 generally is required to provide the issuing banks with collateral to cover such amounts. As a result of the size of the Company's capitalization, the Company does not believe that its non-admitted status in any jurisdiction has, or should have, a material adverse effect on its ability to compete or obtain business in the property catastrophe reinsurance market in which it operates, principally because many of the Company's competitors are not admitted or licensed in United States jurisdictions. However, there can be no assurance that increased competitive pressure from current reinsurers and future market entrants or the Company's non-admitted status will not adversely affect the Company. Employees As of March 1, 2001, the Company employed 25 people. The Company believes that its employee relations are satisfactory. None of the Company's employees are subject to collective bargaining agreements, and the Company knows of no current efforts to implement such agreements at the Company. Regulation and tax matters Bermuda The Insurance Act 1978, as amended, and related regulations (the "Insurance Act"). As a holding company, the Company is not subject to Bermuda insurance regulations. However, LaSalle Re and LaSalle Re Capital are regulated by the Insurance Act, which provides that no person shall carry on an insurance business in or from within Bermuda unless registered as an insurer under the Insurance Act by the Minister of Finance. Under the Insurance Act, insurance business includes reinsurance business. The Minister, in deciding whether to grant registration, has broad discretion to act as he thinks fit in the public interest. The Minister is required by the Insurance Act to determine whether the applicant is a fit and proper body to be engaged in the insurance business and, in particular, whether it has, or has available to it, adequate knowledge and expertise. The registration of an applicant as an insurer is subject to its complying with the terms of its registration and such other conditions as the Minister may impose at any time. The Insurance Act distinguishes between insurers carrying on long-term business and insurers carrying on general business. There are four classifications of insurers carrying on general business, with Class 4 insurers subject to the strictest regulation. LaSalle Re is registered as a Class 4 insurer in Bermuda and is regulated as such under the Insurance Act. The Insurance Act imposes on Bermuda insurance companies solvency and liquidity standards and auditing and reporting requirements and grants to the Minister powers to supervise, investigate and intervene in the affairs of insurance companies. Although LaSalle Re Capital is governed by the Insurance Act, it is exempted from complying with most of the filings required to be made by insurance companies by section 57 of the Insurance Act. Significant aspects of the Bermuda insurance regulatory framework are set forth below. Cancellation of insurer's registration. An insurer's registration may be canceled by the Minister on certain grounds specified in the Insurance Act, including failure of the insurer to comply with its obligations under the Insurance Act or, if in the opinion of the Minister after consultation with the Insurance Advisory Committee appointed by the Minister, the insurer has not been carrying on business in accordance with sound insurance principles. Independent approved auditor. Every registered insurer must appoint an independent auditor who will annually audit and report on the statutory financial statements and the statutory financial return of the insurer. In the case of LaSalle Re, both the statutory financial statements and the statutory financial return are required to be filed annually with the Supervisor of Insurance, who is the chief administrative officer under the Insurance 14 Act. The independent auditor of the insurer must be approved by the Minister and may be the same person or firm that audits the insurer's financial statements and reports for presentation to its shareholders. Loss reserve specialist. As a Class 4 insurer, LaSalle Re is required to submit an annual loss reserve opinion when filing the annual statutory financial return. This opinion must be issued by a loss reserve specialist. The loss reserve specialist, who will normally be a qualified casualty actuary, must be approved by the Minister. Statutory financial statements. An insurer must prepare statutory financial statements annually. The Insurance Act prescribes rules for the preparation and substance of such statutory financial statements, which include, in statutory form, a balance sheet, income statement, statement of capital and surplus and detailed notes thereto. The insurer is required to give detailed information and analyses regarding premiums, claims, reinsurance and investments. The statutory financial statements are not prepared in accordance with GAAP and are distinct from the financial statements prepared for presentation to the insurer's shareholders under the Companies Act 1981 of Bermuda (the "Companies Act"), which financial statements may be prepared in accordance with GAAP. LaSalle Re is required to submit the statutory financial statements as part of the annual statutory financial return. However, the statutory financial statements and the statutory financial return do not form part of the public records maintained by the Supervisor. Annual statutory financial return. LaSalle Re is required to file annually with the Supervisor a statutory financial return no later than four months after its financial year end unless specifically extended. The statutory financial return includes, among other matters, a report of the approved independent auditor on the statutory financial statements of the insurer; a declaration of the statutory ratios; a solvency certificate; the statutory financial statements themselves; the opinion of the approved loss reserve specialist and certain details concerning ceded reinsurance. The solvency certificate and the declaration of the statutory ratios must be signed by the principal representative and at least two directors of LaSalle Re who are required to state whether the minimum solvency margin and, in the case of the solvency certificate, the minimum liquidity ratio have been met, and the independent approved auditor is required to state whether in its opinion it was reasonable for them to so state and whether the declaration of the statutory ratios complies with the requirements of the Insurance Act. The statutory financial return must include the opinion of the loss reserve specialist in respect of the loss and loss expense provisions of LaSalle Re. Where LaSalle Re's accounts have been audited for any purpose other than compliance with the Insurance Act, a statement to that effect must be filed with the statutory financial return. Minimum solvency margin. The Insurance Act provides that the statutory assets of an insurer must exceed its statutory liabilities by an amount greater than the prescribed minimum solvency margin, which varies with the type of business and class of registration of the insurer and the insurer's net premiums written and loss reserve level. As a registered Class 4 insurer, LaSalle Re is required to maintain a minimum solvency margin equal to the greatest of (1) $100 million, (2) 50% of its net premiums written (without deducting more than 25% of gross premiums written when computing net premiums written) and (3) 15% of its loss and other certain insurance reserves. At December 31, 2001, LaSalle Re's actual statutory capital and surplus was $430.5 million, compared to its minimum solvency margin requirement of $100 million. Minimum liquidity ratio. The Insurance Act provides a minimum liquidity ratio for general business. An insurer engaged in general business is required to maintain the value of its relevant assets at not less than 75% of the amount of its relevant liabilities. Relevant assets include cash and time deposits, quoted investments, unquoted bonds and debentures, first liens on real estate, investment income due and accrued, accounts and premiums receivable and reinsurance balances receivable. There are certain categories of assets which, unless specifically permitted by the Minister, do not automatically qualify as relevant assets, such as unquoted equity securities, investments in and advances to affiliates, real estate and collateral loans. The relevant liabilities are total general business insurance reserves and total other liabilities less deferred income tax and sundry liabilities (by interpretation, those not specifically defined). 15 Supervision, investigation and intervention. The Minister may appoint an inspector with extensive powers to investigate the affairs of an insurer if the Minister believes that an investigation is required in the interest of the insurer's policyholders or persons who may become policyholders. In order to verify or supplement information otherwise provided to him, the Minister may direct an insurer to produce documents or information relating to matters connected with the insurer's business. If it appears to the Minister that there is a risk of the insurer becoming insolvent or that it is in breach of the Insurance Act or any conditions imposed upon its registration, the Minister may direct the insurer not to take on any new insurance business; not to vary any insurance contract if the effect would be to increase the insurer's liabilities; not to make certain investments; to realize certain investments; to maintain in or transfer to the custody of a specified bank, certain assets; not to declare or pay any dividends or other distributions or to restrict the making of such payments; and/or to limit its premium income. Principal representative. An insurer is required to maintain a principal office in Bermuda and to appoint and maintain a principal representative in Bermuda. For the purpose of the Insurance Act, the principal office of LaSalle Re is at the Company's offices at 25 Church Street, Hamilton HM 12 Bermuda, and Guy Hengesbaugh is the principal representative of LaSalle Re. Without a reason acceptable to the Minister, an insurer may not terminate the appointment of its principal representative, and the principal representative may not cease to act as such, unless 30 days' notice in writing to the Minister is given of the intention to do so. It is the duty of the principal representative, within 30 days of his reaching the view that there is a likelihood of the insurer for which he acts becoming insolvent or its coming to his knowledge, or his having reason to believe, that a reportable "event" has occurred, to make a report in writing to the Minister setting out all the particulars of the case that are available to him. Examples of such a reportable "event" include failure by the reinsurer to comply substantially with a condition imposed upon the reinsurer by the Minister relating to a solvency margin or a liquidity or other ratio. Class 4 insurer. LaSalle Re is registered as a Class 4 insurer and, as such: (1) is required to maintain a minimum statutory capital and surplus equal to the greatest of $100 million, 50% of its net premiums written (without deducting more than 25% of gross premiums written when computing net premiums written) and 15% of its loss and other insurance reserves; (2) is required to file annually within four months following the end of the relevant financial year with the Supervisor, inter alia, a statutory financial return together with a copy of its annual statutory financial statements and an opinion of a loss reserve specialist in respect of its loss and loss expense provisions; (3) is prohibited from declaring or paying any dividends during any financial year if it is in breach of its minimum solvency margin or minimum liquidity ratio or if the declaration or payment of such dividends would cause it to fail to meet such margin or ratio (if it has failed to meet its minimum solvency margin or minimum liquidity ratio on the last day of any financial year, LaSalle Re will be prohibited, without the approval of the Minister, from declaring or paying any dividends during the next financial year); (4) is prohibited from declaring or paying in any financial year dividends of more than 25% of its total statutory capital and surplus (as shown on its previous financial year's statutory balance sheet) unless it files (at least 7 days before payment of such dividends) with the Supervisor an affidavit stating that it will continue to meet the required margins; (5) is prohibited, without the prior approval of the Minister, from reducing by 15% or more its total statutory capital, as set out in its previous year's financial statements; and (6) is required, at any time it fails to meet its solvency margin, within 30 days (45 days where total statutory capital and surplus falls to $75 million or less) after becoming aware of that failure or having reason to believe that such failure has occurred to file with the Minister a written report containing certain information. Certain other considerations. As "exempted" companies, the Company, LaSalle Re and LaSalle Re Capital may not, without the express authorization of the Bermuda legislature or a license granted by a Minister, participate in certain business transactions, including: (1) the acquisition or holding of land in Bermuda (except that required for its business and held by way of lease or tenancy agreement for a term not exceeding 50 years or that used to provide accommodation or recreational facilities for its officers and employees and held with the consent of the Minister for a term not exceeding 21 years); (2) the taking of mortgages on land in 16 Bermuda in excess of $50,000; or (3) the carrying on of business of any kind in Bermuda, except in certain limited circumstances such as doing business with another exempted undertaking in furtherance of business carried on outside Bermuda. The Bermuda government encourages foreign "entities" like the Company that are based in Bermuda but do not operate in competition with local businesses. As well as having no restrictions on the degree of non-Bermudian ownership, the Company, LaSalle Re and LaSalle Re Capital are not currently subject to taxes on their income or dividends or to any foreign exchange controls in Bermuda. In addition, there currently is no capital gains tax in Bermuda, and profits can be accumulated by the Company, LaSalle Re and LaSalle Re Capital, as required, without limitation under general Bermuda law. The Companies Act prohibits a company from declaring or paying a dividend, or making a distribution out of contributed surplus, if there are reasonable grounds for believing that (1) the Company is, or would after the payment be, unable to pay its liabilities as they come due; or (2) the realizable value of the Company's assets would thereby be less than the aggregate of its liabilities and shareholders' equity. This restriction applies to the Company, LaSalle Re and LaSalle Re Capital as Bermuda exempted companies. LaSalle Re Capital LaSalle Re Capital became a Corporate Member of Lloyd's in December 1996 and commenced underwriting effective January 1, 1997. LaSalle Re Capital is only licensed to carry on business related to Lloyd's. As a Corporate Member, LaSalle Re Capital is subject to the regulatory jurisdiction of the Council of Lloyd's. Lloyd's operates under a self-regulatory regime under the Lloyd's Act 1982 and has the power to set, interpret and change the rules which govern the operation of the Lloyd's market, Lloyd's prescribes, in respect of its managing agents and corporate members, certain minimum standards relating to their management and control, solvency and various other requirements. In addition, Lloyd's imposes restrictions against persons becoming controllers and major shareholders of managing agents and corporate members without the consent of Lloyd's first having been obtained. In 2000, the Financial Services and Markets Bill established the Financial Services Authority as a single regulator to supervise securities, banking and insurance business, including Lloyd's. In 2001, the Financial Services Authority gained wider authorization and intervention powers in relation to Lloyd's as part of the implementation of the Financial Services and Markets Act. As a Corporate Member of Lloyd's, LaSalle Re Capital is required to file audited financial statements and an annual return, which is part of the annual declaration of compliance process. The annual declaration of compliance sets out the financial position of the Corporate Member and confirms details of its directors and controllers. In addition, LaSalle Re Capital is required to file an audited solvency return either confirming the value of funds at Lloyd's ("FAL") held by the member as at the previous December 31, or that it held no FAL at that date. Lloyd's will compare the value of a Corporate Member's FAL derived from the solvency return with its underwriting assets and liabilities as reported by the syndicates on which it participates. Where a negative solvency position is disclosed, the Corporate Member is required to provide sufficient additional funds to cover the shortfall. Under the terms of its license as a "member of a recognised association of underwriters" under the Bermuda Insurance Act, LaSalle Re Capital is required to meet and maintain the solvency requirements of Lloyd's. LaSalle Re Capital is also required to send to the Bermuda Supervisor of Companies, within 30 days after submission of the annual solvency return and declaration of compliance to Lloyd's, a copy of those documents together with a copy of the audited annual statements of each of the syndicates in which LaSalle Re Capital participates. Further, LaSalle Re Capital must also appoint and maintain a principal representative in Bermuda. 17 United States, United Kingdom and other LaSalle Re is registered as an insurer and is subject to regulation and supervision in Bermuda. LaSalle Re is not admitted or authorized to do business in any jurisdiction except Bermuda. The insurance laws of each state of the United States do not directly regulate the sale of reinsurance within their jurisdictions by alien insurers, such as LaSalle Re. Nevertheless, the sale of reinsurance by alien reinsurers, such as LaSalle Re, to insurance companies domiciled or licensed in United States jurisdictions is indirectly regulated by state "credit for reinsurance" laws that operate to deny financial statement credit to ceding insurers unless the non-admitted alien reinsurer posts acceptable security for ceded liabilities and agrees to prescribed contract provisions, such as insolvency and intermediary clauses. The Company conducts its business at its principal offices in Bermuda and does not maintain an office in the United States, and its personnel do not solicit, advertise, settle claims or conduct other insurance activities in the United States. All policies are issued and delivered and premiums are received outside the United States. The Company does not believe that it is subject to the insurance laws of any state in the United States. From time to time, there have been congressional and other initiatives in the United States regarding the supervision and regulation of the insurance industry, including proposals to supervise and regulate alien reinsurers. While none of these proposals have been adopted to date on either the federal or state level, there can be no assurance that federal or state legislation will not be enacted subjecting the Company to supervision and regulation in the United States, which could have a material adverse effect on the Company. In addition, no assurance can be given that if the Company were to become subject to any laws of the United States or any state thereof or of any other country at any time in the future, it would be in compliance with such laws. LaSalle Re does not intend to maintain an office or to solicit, advertise, settle claims or conduct other insurance activities in any jurisdiction other than Bermuda where the conduct of such activities would require that LaSalle Re be so admitted. ITEM 2. PROPERTIES The Company's executive offices are located in approximately 10,000 square feet of leased office space in Hamilton, Bermuda. Management believes the Company's current office space is adequate for its needs. ITEM 3. LEGAL PROCEEDINGS The Company and its subsidiaries are at times party to various legal proceedings generally arising in the normal course of its business. The Company does not believe that the eventual outcome of any such proceeding will have a material effect on its financial condition or business. Pursuant to the Company's reinsurance arrangements, disputes are generally required to be finally settled by arbitration. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of shareholders of the Company during the fourth fiscal quarter of the calendar year ended December 31, 2001. PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS Following the business combination with Trenwick, the Company's Common Shares, which were quoted on The New York Stock Exchange under the symbol "LSH", were delisted. There is no established public trading market for the Company's Common Shares, all of which are owned by Trenwick. 18 In the year ended September 30, 1999, the Company paid a quarterly dividend of $0.375 on its common stock for the first three quarters of the year. No further dividends on common stock were paid by the Company while its common stock was publicly held. The Company paid a quarterly dividend of $.547 on its Series A preferred shares in each of the four quarters of 2001, 2000 and 1999. ITEM 6. SELECTED FINANCIAL DATA Expressed in thousands of United States Dollars, except other data. The 2001 and 2000 years relates to a December 31 year end and the 1999, 1998, 1997 and 1996 years relates to September 30 year end.
2001 Year 2000 Year 1999 Period 1999 Year 1998 Year 1997 Year --------- --------- ----------- --------- --------- --------- Statement of Income Data Gross premiums written $145,532 $130,163 $10,307 $139,010 $155,316 $171,386 Net premiums earned 97,542 108,096 30,391 126,615 154,620 163,933 Net investment income (including realized gains and losses) 46,495 35,756 8,588 34,462 39,863 33,664 Claims and claims expenses incurred 122,981 80,586 46,642 131,147 95,539 31,199 Policy acquisition costs 20,887 21,270 5,878 19,844 22,661 26,018 Underwriting expenses 11,771 13,342 4,533 13,733 8,932 12,656 Income (loss) before minority interest (11,245) 24,104 (19,831) (5,679) 65,232 121,468 Minority interest(1) 839 (4,990) (2,845) 13,426 24,391 Net income (loss) (11,245) 23,265 (14,841) (2,834) 51,806 97,077 Common dividends declared 7,500 1,500 -- 17,543 44,641 44,860 Other Data Loss ratio 126.1% 74.6% 153.5% 103.6% 61.8% 19.0% Expense ratio 33.5% 32.0% 34.3% 26.5% 20.4% 23.6% Combined ratio 159.6% 106.6% 187.8% 130.1% 82.2% 42.6% Balance Sheet Data (at end of period) Total investments and cash 507,278 $499,666 $559,591 $556,976 $606,757 $553,043 Total assets 802,320 725,495 726,168 736,107 757,290 686,088 Reserve for losses and loss expenses 280,487 174,763 190,352 146,552 97,942 45,491 Minority interest -- -- 86,906 93,055 105,569 93,355 Total shareholders' equity 437,596 464,091 361,960 382,197 430,053 425,226
-------- (1) Minority interest represents those shares in LaSalle Re Limited that were held as Exchangeable Non-Voting Shares. These shares were exchangeable, at the option of the holder, for Common Shares of the Company on a one-for-one basis. These shares were exchanged for Trenwick Common Shares on a one-for-one basis following the Trenwick/LaSalle business combination. 19 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION The following discussion highlights material factors affecting the Company's results of operations for the three years ended December 31, 2001, December 31, 2000 and September 30, 1999. This discussion and analysis should be read in conjunction with the audited consolidated financial statements and notes thereto of the Company contained in Item 8 of this Form 10-K. Results of Operations - Years Ended December 31, 2001 and 2000
2001 Year 2000 Year Change --------- --------- ------ (in thousands) Underwriting loss $(58,115) $ (7,102) $(51,013) Net investment income 38,928 37,444 1,484 Interest expense -- (1,173) 1,173 Corporate expenses -- (3,255) 3,255 -------- -------- -------- Operating income (loss) (19,187) 25,914 (45,101) Net realized investment (losses) gains 7,567 (1,688) 9,255 Goodwill accretion 488 122 366 Foreign currency losses (113) (244) 131 -------- -------- -------- Income (loss) before minority interest (11,245) 24,104 (35,349) Minority interest in net (income) loss of subsidiary -- (839) 839 -------- -------- -------- Net income (loss) (11,245) 23,265 (34,510) Dividends on preferred stock (6,563) (6,563) -- -------- -------- -------- Net income (loss) available to common shareholders $(17,808) $ 16,702 $(34,510) ======== ======== ========
The operating loss of $19.2 million in 2001 represented a $45.1 million decrease over the operating income of $25.9 million recorded in 2000. This decrease was primarily due to the deterioration of underwriting results caused by losses incurred related to Tropical Storm Alison ($8.0 million) and the September 11th terrorist attacks ($141.8 million gross and $86.8 million net of reinsurance recoverable). The adverse effect of the underwriting performance primarily generated the decrease in net income of $34.5 million. Underwriting income (loss)
2001 Year 2000 Year Change --------- --------- ------ (in thousands) Net premiums earned $ 97,542 $108,096 $(10,554) -------- -------- -------- Claims and claims expenses incurred (122,981) (80,586) (42,395) Acquisition costs and underwriting expenses (32,676) (34,612) 1,936 -------- -------- -------- Total underwriting costs and expenses (155,657) (115,198) (40,459) -------- -------- -------- Net underwriting loss $(58,115) $ (7,102) $(51,013) ======== ======== ======== Loss ratio 126.1% 74.6% 51.5% Underwriting expense ratio 33.5% 31.9% 1.6% -------- -------- -------- Combined ratio 159.6% 106.5% 53.1%
20 The underwriting loss of $58.1 million in 2001 represented a $51.0 million increase compared to the underwriting loss of $7.1 million in the 2000 year. The underwriting loss in 2001 included losses of $122.0 million on current year loss events and net additions to prior years' reserves of $1.0 million. Of this $123.0 million total loss incurred, $22.1 million relates to Lloyd's syndicates which are now in run-off. The underwriting loss in 2000 included both losses of $60.2 million on current year loss events and additions to prior years' reserves of $20.4 million. The effect of losses from the September 11th terrorist attacks is an increase in the underwriting loss of $97.8 million resulting from increase in claims and claims expenses incurred of $86.8 million and a decrease in net premiums earned of $10.2 million due to net reinstatement premiums on assumed and ceded contracts. This effect on the combined ratio was 96.4 percentage points principally from increases in the loss ratio. Premiums written Gross premiums written for 2001 were $145.5 million compared to $130.2 million for 2000, an increase of $15.3 million or 11.8%. Details of gross premiums written are provided below.
2001 Year 2000 Year Change --------- --------- ------ (in thousands) Worldwide property catastrophe reinsurance $140,331 $101,570 $38,761 Lloyd's syndicates 5,201 28,593 (23,392) -------- -------- ------- Total $145,532 $130,163 $15,369 ======== ======== =======
The increase in worldwide property catastrophe reinsurance gross premium writings for 2001 compared to 2000 resulted primarily from reinstatement premiums of $14.4 million generated by reinstated coverages on assumed contracts impacted by losses from the September 11th terrorist attacks. The decrease in Lloyd's sydicates gross written premiums for 2001 compared to 2000 is expected as all of the Lloyd's sydicates business underwritten by the Company prior to the combination with Trenwick has not been renewed in 2001 and has been classified as runoff. Premiums earned
2001 Year 2000 Year Change --------- --------- ------ (in thousands) Gross premiums written $ 145,532 $ 130,163 $ 15,369 Change in gross unearned premiums 4,992 9,966 (4,974) --------- --------- -------- Gross premiums earned 150,524 140,129 10,395 --------- --------- -------- Premiums ceded (50,453) (31,631) (18,822) Change in premiums ceded (2,529) (402) (2,127) --------- --------- -------- Amortized ceded premiums (52,982) (32,033) (20,949) --------- --------- -------- Net premiums earned $ 97,542 $ 108,096 $(10,554) ========= ========= ========
Gross premiums ceded for 2001 were $50.5 million compared to $31.6 million for 2000. This increase was primarily due to reinstated covers of $19.3 million on ceded contracts following the September 11th terrorist attacks. Net premiums earned in 2001 were $97.5 million compared to $108.1 million for 2000. The decrease in net premiums earned is primarily due to the increase in ceded premiums. 21 Claims and claims expenses Claims and claims expenses for 2001 were $123.0 million, a increase of $42.4 million compared to claims and claims expenses of $80.6 million for 2000. The increase is due to losses associated with the September 11th terrorist attacks. The Company's incurred losses related to the September 11th terrorist attacks are based upon estimates of its ultimate exposure derived from a manual assessment of its outstanding policies. The assessment included market share analysis, probable maximum loss analysis, independent risk modeling analysis and cedent loss estimates. The Company's primary exposure for this event relates to commercial property damage, which includes business interruption and incidental workers' compensation coverage, and catastrophe aviation coverage. The Company's estimated loss from the September 11th terrorist attacks is $141.8 million gross and $86.8 million net of reinsurance recoverable. The reinsurance recoverable of $55.0 million related to the terrorist attacks is from companies which have financial strength ratings from A.M. Best of "A" or better. In addition to losses incurred related to the September 11th terrorist attack, the Company incurred losses of $8.0 million associated with Tropical Storm Alison. Claims and claims expenses incurred in 2000 included $6.5 million of catastrophe losses relating to U.K. floods and an increase of $20.4 million in prior period occurrences, principally losses relating to two storms, Martin and Anatol, which hit Europe in late December 1999. Underwriting expenses 2001 Year 2000 Year Change --------- --------- ------ (in thousands) Policy acquisition costs $20,886 $21,270 $ (384) Underwriting expenses 11,790 13,342 (1,552) ------- ------- ------- Total underwriting expenses $32,676 $34,612 $(1,936) ======= ======= ======= Underwriting expense ratio 33.5% 31.9% 1.6% ======= ======= ======= Total underwriting expenses, comprising policy acquisition costs and underwriting expenses, for 2001 decreased by $1.9 million compared to total underwriting expenses for 2000. Policy acquisition costs as a percentage of net premiums earned were 21.4% for 2001 compared to 19.7% for 2000. The increase in the ratio occurred principally because of an increase in the amount of amortized ceded premiums. As a percentage of gross premiums earned, policy acquisition costs were 13.9% in 2001 compared to 15.2% in 2000. The decrease of 1.3% was primarily due to the Company deriving less premiums from LaSalle Re Capital which has a higher expense ratio than the rest of the business. Underwriting expenses for 2001 were $11.8 million compared to $13.3 million for 2000, a decrease of $1.5 million. The decrease is primarily due to a reduction in overall salary costs. Net investment income 2001 Year 2000 Year Change --------- --------- ------ (in thousands) Average invested assets $ 491,861 $ 508,081 $(16,220) Average annualized yields 7.5% 7.0% 0.5% Investment income - portfolio 37,016 35,691 1,325 Investment income - non-portfolio 2,548 2,667 (119) Investment expenses (636) (914) 278 --------- --------- -------- Net investment income $ 38,928 $ 37,444 $ 1,484 ========= ========= ======== Net investment income for 2001 was $38.9 million compared to $37.4 million for 2000. The increase in net investment income in 2001 was primarily due to changes in the allocation of investments to higher yielding debt securities following a change in investment managers. 22 Interest expense Interest expense was $1.1 million in 2000. There were no interest expense charges in 2001. Interest expense in 2000 included financing charges associated with a ceded reinsurance contract and other interest expenses related to the commitment fees payable on the Company's credit facility which was canceled effective the end of September, 2000. Corporate expenses The Company did not record any corporate expenses for 2001. The expenses of $3.3 million for 2000 relate primarily to the Company's decision to cancel the implementation of new reinsurance software and costs related to the Trenwick/LaSalle business combination. Non-operating income and expenses Net realized gains on investments were $7.6 million during 2001, compared to net realized losses of $1.7 million for 2000. The gains in 2001 resulted from a change in investment managers and a consequential re-positioning of the portfolio to reflect a new investment philosophy. The Company recorded minimal foreign currency losses in 2001 and 2000. Results of Operations - Year Ended December 31, 2000 and Fiscal Year Ended September 30, 1999
2000 Year 1999 Year Change --------- --------- ------ (in thousands) Underwriting loss $ (7,102) $(38,109) $ 31,007 Net investment income 37,444 33,847 3,597 Interest expense (1,173) (1,714) 541 Corporate expenses (3,255) (788) (2,467) -------- -------- -------- Operating income (loss) 25,914 (6,764) 32,678 Net realized investment (losses) gains (1,688) 615 (2,303) Goodwill accretion 122 0 122 Foreign currency (losses) gains (244) 470 (714) -------- -------- -------- Income (loss) before minority interest 24,104 (5,679) 29,783 Minority interest in net (income) loss of subsidiary (839) 2,845 (3,684) -------- -------- -------- Net income (loss) 23,265 Dividends on preferred stock (6,563) (6,563) -- -------- -------- -------- Net income (loss) available to common shareholders $ 16,702 $ (9,397) $ 26,099 ======== ======== ========
Operating income of $25.9 million in 2000 represented a $32.7 million increase over the operating loss of $6.8 million recorded in fiscal year 1999. This improvement was principally due to better underwriting results in 2000, which was due to a decrease in prior year reserve strengthening to both catastrophe and non-catastrophe business. The effect of the improved underwriting performance primarily generated the increase in net income of $26.1 million. 23 Underwriting income (loss)
2000 Year 1999 Year Change --------- --------- ------ (in thousands) Net premiums earned $ 108,096 $ 126,615 $(18,519) --------- --------- -------- Claims and claims expenses incurred (80,586) (131,147) 50,561 Acquisition costs and underwriting expenses (34,612) (33,577) (1,035) --------- --------- -------- Total underwriting costs and expenses (115,198) (164,724) 49,526 --------- --------- -------- Net underwriting loss $ (7,102) $ (38,109) $ 31,007 ========= ========= ======== Loss ratio 74.6% 103.6% (29.0%) Underwriting expense ratio 31.9% 26.5% 5.4% --------- --------- -------- Combined ratio 106.5% 130.1% (23.6%)
The underwriting loss of $7.1 million in 2000 represented a $31.0 million decrease compared to the underwriting loss of $38.1 million in the 1999 fiscal year. The underwriting loss in 2000 included both losses of $60.2 million on current year loss events and additions to prior years' reserves of $20.4 million. The underwriting results for the 1999 fiscal year included both losses of $82.5 million relating to current year events and additions to prior year loss reserves of $48.6 million. The decrease in the combined ratio in 2000 compared to fiscal year 1999 resulted primarily from an improvement in the loss ratio due to lower catastrophe losses in the 2000 year and reduced additions to prior year loss reserves. Premiums written Gross premiums written for 2000 were $130.2 million compared to $139.0 million for the 1999 fiscal year, a decrease of $8.8 million or 6%. Details of gross premiums written are provided below.
2000 Year 1999 Year Change --------- --------- ------ (in thousands) Worldwide property catastrophe reinsurance $101,570 $116,621 $(15,051) Lloyd's syndicates runoff 28,593 22,389 6,204 -------- -------- -------- Total $130,163 $139,010 $ (8,847) ======== ======== ========
The decrease in worldwide property catastrophe reinsurance gross premium writings for 2000 compared to the 1999 fiscal year resulted primarily from the non-renewal of certain accounts following a re-evaluation of LaSalle Re Limited's worldwide aggregate exposures. The most significant reduction in aggregate exposures came from a reduction in accounts covering European risks. The increase in Lloyd's gross written premiums for 2000 compared to the 1999 fiscal year primarily arose from new information concerning premium estimates for the 1999 and 1998 underwriting years of account. All of the Lloyd's business underwritten by the Company prior to the combination with Trenwick has not been renewed as of December 31, 2000 and has been classified as runoff. 24 Premiums earned 2000 Year 1999 Year Change --------- --------- ------ (in thousands) Gross premiums written $ 130,163 $ 139,010 $ (8,847) Change in gross unearned premiums 9,966 6,070 3,896 --------- --------- -------- Gross premiums earned 140,129 145,080 (4,951) --------- --------- -------- Premiums ceded (31,631) (28,191) (3,440) Change in premiums ceded (402) 9,726 (10,128) --------- --------- -------- Amortized ceded premiums (32,033) (18,465) (13,568) --------- --------- -------- Net premiums earned $ 108,096 $ 126,615 $(18,519) ========= ========= ======== Gross premiums ceded for 2000 were $31.6 million compared to $28.2 million for the 1999 fiscal year. The increase in amortized ceded premiums of $13.6 million was primarily attributable to a full year's cessions to the CNA property catastrophe quota share arrangement in 2000. The facility originally incepted April 1, 1999. In addition the Company also purchased several new protections in 2000. Net premiums earned in 2000 were $108.1 million compared to $126.6 million for the 1999 fiscal year. The decrease in net premiums earned is due to the increase in amortized ceded premiums. Claims and claims expenses Claims and claims expenses for 2000 were $80.6 million, a decrease of $50.6 million compared to claims and claims expenses of $131.1 million for the 1999 fiscal year. The reduction in claims and claims expenses incurred was due to a reduced number of catastrophe losses in 2000 and a reduction in prior year reserve strengthening. Claims and claims expenses incurred in 2000 included $6.5 million of catastrophe losses relating to U.K. floods and an increase of $20.4 million in prior period occurrences, principally losses relating to two storms, Martin and Anatol, which hit Europe in late December 1999. During the 1999 fiscal year, claims and claims expenses incurred included $25.6 million in losses from various catastrophes including Hurricane Floyd, the Australian hailstorm and Oklahoma tornadoes. During the same year, the Company recorded additions to prior year reserves of $14.0 million in respect of Hurricane Georges, which occurred in September 1998, due to an increase in market estimates of the damage caused by the hurricane. The Company also incurred $16.0 million of additional reserves in the 1999 fiscal year following the completion of an evaluation of its catastrophe reserving methodology. In addition, the Company recorded approximately $14.0 million of additional reserves in the 1999 fiscal year relating to contracts written in prior years, including contracts which had incidental extended warranty coverages. Underwriting expenses 2000 Year 1999 Year Change --------- --------- ------ (in thousands) Policy acquisition costs $21,270 $19,844 $ 1,426 Underwriting expenses 13,342 13,733 (391) ------- ------- ------- Total underwriting expenses $34,612 $33,577 $ 1,035 ======= ======= ======= Underwriting expense ratio 31.9% 26.5% 5.4% ======= ======= ======= Total underwriting expenses, comprising policy acquisition costs and underwriting expenses, for 2000 increased by $1.0 million compared to total underwriting expenses for the 1999 fiscal year. Policy acquisition costs as a percentage of net premiums earned were 19.7% for 2000 compared to 15.7% for the 1999 fiscal 25 year. The increase in the ratio occurred principally because of an increase in the amount of amortized ceded premiums. As a percentage of gross premiums earned policy acquisition costs were 15.2% compared to 13.7%. The remaining increase of 1.5% was primarily due to the Company deriving more premiums from LaSalle Re Capital which has a higher expense ratio than the rest of the business at 20%. Underwriting expenses for the year 2000 and the 1999 fiscal year remained comparable at 9.5%. Net investment income
2000 Year 1999 Year Change --------- --------- ------ (in thousands) Average invested assets $ 508,081 $ 575,571 $(67,490) Average annualized yields 7.0% 5.7% 1.3% Investment income - portfolio 35,691 32,778 2,913 Investment income - non-portfolio 2,667 1,935 732 Investment expenses (914) (866) (48) --------- --------- -------- Net investment income $ 37,444 $ 33,847 $ 3,597 ========= ========= ========
Net investment income for 2000 was $37.4 million compared to $33.8 million for the 1999 fiscal year. The principal reason for the increase in net investment income in 2000 was the increase in market yields. Interest expense Interest expense was $1.2 million for 2000 a decrease of $0.5 million from the 1999 fiscal year. Interest expense included financing charges associated with a ceded reinsurance contract and other interest expenses related to the commitment fees payable on the Company's credit facility which was canceled effective the end of September, 2000. Corporate expenses Corporate expenses were $3.3 million for 2000 compared to $0.8 million for 1999. The increase in the expense was due to the write off of a new reinsurance system following the cancellation of the implementation. The Company had originally capitalized the system and intended to depreciate the asset once the system was in operation. Non-operating income and expenses Net realized losses on investments were $1.7 million during 2000, compared to net realized gains of $0.6 million for the 1999 fiscal year. Both the losses and gains were made as a result of security sales executed pursuant to an investment policy designed to protect the total returns on the portfolio. The Company recorded foreign currency losses of $0.2 million for 2000, compared to foreign currency gains of $0.4 million for the 1999 fiscal year due to the decline in the value of European currencies against the US dollar. Liquidity and capital resources As a holding company, the Company's assets consist primarily of all of the outstanding voting stock of LaSalle Re. The Company's cash flows depend primarily on dividends and other permitted payments from LaSalle Re and its subsidiaries. 26 LaSalle Re's sources of funds consist of net premiums written, investment income and proceeds from sales and redemptions of investments. Cash is used primarily to pay losses and loss expenses, brokerage, commissions, excise taxes, administrative expenses and dividends. Under the Insurance Act, LaSalle Re is prohibited from paying dividends of more than 25% of its opening statutory capital and surplus unless it files with the Bermuda Supervisor of Companies an affidavit (at least 7 days before payment of such dividends) stating that it will continue to meet the required minimum solvency margin and minimum liquidity ratio requirements and from declaring or paying any dividends without the prior approval of the Bermuda Minister of Finance if it failed to meet its required margins on the last day of the previous fiscal year. The Insurance Act also requires LaSalle Re to maintain a minimum solvency margin and minimum liquidity ratio and prohibits dividends that would result in a breach of these requirements. In addition, LaSalle Re is prohibited under the Insurance Act from reducing its opening total statutory capital by 15% or more without the approval of the Minister of Finance. LaSalle Re currently meets these requirements. Operating activities produced a net cash inflow of $51.9 million for the year ended December 31, 2001 compared to $10.7 million for the year ended December 31, 2000. The increase was partially from the collection of a deposit of approximately $27.4 million on the Company's multi year reinsurance contract which was cancelled effective December 31, 2000. Cash flows from operations in future years may differ substantially from net income. Cash flows are affected by loss payments, which, due to the nature of the reinsurance coverage provided by LaSalle Re, are generally expected to comprise large loss payments on a limited number of claims and can therefore fluctuate significantly from year to year. The irregular timing of these large loss payments can create significant variations in operating cash flows between periods. LaSalle Re funds these payments from cash flows from operations and sales of investments. Loss payments following the September 11th terrorist attack have not been significant in 2001. Loss payments from this event are expected to be significant in 2002 and 2003. As a result of the potential for large loss payments, LaSalle Re maintains a substantial portion of its assets in cash and debt securities. As of December 31, 2001, 68% of its total assets were held in cash and investments, which totaled $543.7 million compared to 69% at December 31, 2000 or $499.7 million. The increase in cash and investments of $44.0 million was primarily due to the reinvestment of surplus cash flows. To further mitigate the uncertainty surrounding the amount and timing of potential liabilities and to minimize interest rate risk, LaSalle Re maintains a short average duration for its investment portfolio. The Company has decreased the modified average duration of the portfolio from 2.9 years at December 31, 2000 to 2.7 years at December 31, 2001. As of December 31, 2001, 73% of the debt securities held in the Company's investment portfolio were rated "AA" or better and 87% were rated "A" or better by Standard and Poor's or Moody's. No single investment comprised more than 5% of the overall portfolio. Premiums receivable were $86.2 million at December 31, 2001 compared to $77.2 million at December 31, 2000. The increase was due to reinstatement premiums generated by reinstated coverages on assumed contracts impacted by losses from the September 11th terrorist attacks. Other assets decreased from $30.3 million as at December 31, 2000 to $3.2 million at December 31, 2001. The decrease is related to collection of the deposit on the Company's multi-year reinsurance contract. At December 31, 2001, reserves for unpaid claims and claims expenses were $280.5 million compared to $174.8 million at December 31, 2000. Included in the reserve for unpaid claims and claims expenses at December 31, 2001, was an amount of $42.1 million compared to $37.2 million at December 31, 2000 in respect of the business underwritten by LaSalle Re Capital. At December 31, 2001, reinsurance recoverable balances were $57.2 million compared to $6.4 million as at December 31, 2000. The increase in unpaid claims and claims expenses and reinsurance recoverable balances of $105.7 million and $50.8 million, respectively was due to the impact on net losses incurred following the September 11th terrorist attacks. 27 The reduction in unearned premium by $5.0 million from December 31, 2000 to December 31, 2001 was primarily caused by the change in the mix of business in the 2001 year. The negative goodwill of $11.9 million as of December 31, 2001 relates to the Trenwick/LaSalle business combination. The Company has adopted the push-down basis of accounting for the purchase of the minority interest in LaSalle Re in its financial statements. In July 2001, the Financial Accounting Standards Board issued a statement covering goodwill which is required to be adopted at the beginning of 2002. See Note 11 of Notes to the Consolidated Financial Statements for details. In accordance with the terms of certain reinsurance contracts, the Company has posted letters of credit in the amount of $72.1 million as of December 31, 2001 as compared to $20.5 million as of December 31, 2000 to support outstanding loss reserves. In connection with LaSalle Re Capital's support of three Lloyd's syndicates, the Company posted letters of credit in the amount of $14.3 million (equivalent to (pound)9.8 million). All letters of credit are secured by a lien on the Company's investment portfolio equal to approximately 115% of the amount of the outstanding letters of credit. The Company paid a quarterly dividend of $0.5469 per share to holders of record of Series A preferred shares in March, June, September and December of 2001. As of December 31, 2001, dividends due but not yet declared on the Series A preferred shares amounted to $0.5 million. In addition, the Company paid common dividends to Trenwick in 2001 totalling $7.5 million. The Company has no material commitments for capital expenditures. In connection with the Company's Trenwick/LaSalle business combination, the Company cancelled its stand alone committed line of credit for $100 million effective September 27, 2000. Concurrent with the Trenwick/LaSalle business combination, Trenwick entered into an amended and restated $490 million credit agreement with various lending institutions. The agreement consists of both a $260 million revolving credit facility and a $230 million letter of credit facility. The revolving credit facility has subsequently been converted into a four-year term loan. The primary obligors are two of Trenwick's subsidiary companies. Guarantees are provided by the Company with respect to these obligations. The letter of credit facility is scheduled to expire in November 2002. The term loan facility is subject to scheduled principal amortization over the four-year period in accordance with the following schedule: 2002, 22.5%; 2003, 27.5%; 2004, 32.5%; 2005, 17.5%. The applicable interest rate on borrowings under the credit facility is generally 2.5% above the London Interbank Offered Rate and was 4.7% at year end 2001. A portion or all of the term loan must be repaid in the event of equity issuances, asset sales or debt issuances by Trenwick or its subsidiaries. At year end 2001, $195.0 million of term loans were outstanding, and $230.0 million of letters of credit were outstanding under the credit facility. The credit agreement contains general covenants and restrictions as well as financial covenants relating to, among other things, Trenwick's minimum interest coverage, debt to capital leverage, minimum earned surplus, maintenance of a minimum A.M. Best Company rating of A- and tangible net worth. As of year end 2001, Trenwick was in compliance with the credit agreement covenants. The financial covenants relating to interest coverage, risk based capital and tangible net worth (each as defined by the financial covenants in the credit agreement) were revised downward in an amendment to the credit agreement executed following the September 11th terrorist attacks. The amendment set Trenwick's minimum interest coverage ratio at 1.5 to 1 for the fourth quarter of 2001, 2.0 to 1 for the first quarter of 2002 and 2.5 28 to 1 thereafter. Trenwick's interest coverage ratio at December 31, 2001 was 2.0 to 1. The amendment adjusted downward the minimum risk-based capital requirement for Trenwick's subsidiary, Chartwell Insurance Company, from 300% to 225% through December 31, 2001. Thereafter, the minimum risk-based capital for Chartwell Insurance Company returns to 300%. The risk based capital for Chartwell Insurance Company as of December 31, 2001 was 257%. The amendment lowered the base minimum tangible net worth Trenwick must maintain from $560 million to $425 million until the reporting of quarterly results of operations as of March 31, 2002, which are due no later than May 15, 2002. After May 15, 2002, Trenwick minimum tangible net worth reverts to $560 million. Trenwick's tangible net worth as of December 31, 2001 was $428 million. If Trenwick is unable to meet the credit agreement's financial covenants at the end of the first quarter of 2002, it may be required to repay the outstanding indebtedness and collateralize the outstanding letters of credit issued under the credit agreement through additional financing, asset sales, subsidiary dividends or similar transactions. Trenwick's ability to refinance its existing debt obligations or raise additional capital is dependent upon several factors, including financial conditions with respect to both the equity and debt markets and the ratings of its securities as established by the rating agencies. Following Trenwick's claims and claims expense liability reserve increase in the second quarter of 2001 and the losses it sustained in the September 11th terrorist attacks, its senior debt ratings were downgraded by Standard & Poors Corporation to BBB- and by Moody's Investors Service to Ba2. Trenwick's ability to refinance its outstanding debt obligations, as well as the cost of such borrowings, could be adversely affected by these ratings downgrades or if its ratings were downgraded further. Should the two Trenwick subsidiary companies or Trenwick be unable to meet the loan repayments as they fall due, and such repayments are not refinanced, the Company would become liable for such repayments under the terms of the guarantees. No liability for any such amounts has been reflected in the Company's financial statements. Because the two Trenwick subsidiary companies and Trenwick are holding companies, their principal source of funds consists of permissible dividends, tax allocation payments and other statutorily permissible payments from their respective operating subsidiaries. As a result of recent losses incurred by Trenwick's operating subsidiaries, their cash distribution capacities have been significantly reduced. The Company's financial condition and results of operations are influenced by both internal and external forces. Loss payments, investment returns and premiums may be impacted by changing rates of inflation and other economic conditions. Cash flows from operations and the liquidity of its investment portfolio are, in the opinion of the Company, adequate to meet the expected cash requirements of the Company over the next 12 months. Critical Accounting Policies The accounting policies described below are those the Company considers critical in preparing its consolidated financial statements. These policies include significant estimates made by management using information available at the time the estimates are made. However, as described below, these estimates could change materially if different information or assumptions were used. The descriptions below are summarized and have been simplified for clarity. A more detailed description of the significant accounting policies used by the Company in preparing its financial statements is included in the Notes to the Consolidated Financial Statements and the note references are included below. Unpaid Claims and Claims Expenses The Company establishes liability reserves for claims and claims expenses that have been reported but not paid and claims and claims expenses that have been incurred but not reported under its reinsurance contracts. These liability reserves are developed using actuarial principles and assumptions which consider a number of factors, including industry information, contact reviews and historical claims and claims expense patterns, which are described in the Notes to the 29 Consolidated Financial Statements. An extensive degree of judgment is used in this estimation process. Because the future cannot be predicted with certainty, the actual future claims and claims expense payments are usually different from the previously recorded liability reserve estimates. Sometimes the differences are significant. Any adjustments to the Company's liability reserves for claims and claims expenses are included in the Company's results of operations in the period in which the need for the adjustment becomes known. Due to the considerable variability of the reinsurance business underwritten by the Company, adjustments to its liability reserves for claims and claims expenses may occur each quarter and are sometimes significant. In particular, the Company cautions that the claims and claims expense liability reserves related to the September 11th terrorist attacks remain subject to future adjustment. Because of the scope and uniqueness of these events, standard loss modeling and assessment methodologies have limited relevance. As a result, the Company's expected losses reflect the industry's and the Company's current estimates. As additional information regarding the claims and claims expenses related to the September 11th terrorist attacks becomes available, the Company may be required to adjust its estimate in the future. Also see Note 4 of Notes to the Consolidated Financial Statements. Reinsurance Recoverable Balances The Company purchases reinsurance to reduce its exposure on catastrophic losses. The Company estimates the amount of uncollectable receivables from its reinsurers each period and establishes an allowance for uncollectable amounts if necessary. The amount of the allowance is based on the age of unpaid amounts, information about the creditworthiness of the Company's reinsurers, and other relevant information. Estimates of uncollectable reinsurance amounts are revised each period, and changes are recorded in the period they become known. A significant change in the level of uncollectable reinsurance amounts would have a significant effect on the Company's results of operations. Also see Note 4 of Notes to the Consolidated Financial Statements. Investments Investments are classified as available for sale and recorded at fair value, and unrealized investment gains and losses are reflected in shareholders' equity. Investment income is recorded when earned, and capital gains and losses are recognized when investments are sold. Investments are reviewed periodically to determine if they have suffered an impairment of value that is considered other than temporary. If investments are determined to be impaired, a capital loss is recognized at the date of determination. Testing for impairment of investments also requires significant management judgment. The identification of potentially impaired investments, the determination of their fair value and the assessment of whether any decline in value is other than temporary are the key judgment elements. The discovery of new information and the passage of time can significantly change these judgments. Revisions of impairment judgments are made when new information becomes known, and any resulting impairment adjustments are made at that time. The current economic environment and recent volatility of securities markets increase the difficulty of determining fair value and assessing investment impairment. The same influences tend to increase the risk of potentially impaired assets. The Company seeks to match the maturities of invested assets with the payment of expected liabilities. By doing this, the Company attempts to make cash available as payments become due. If a significant mismatch of the maturities of assets and liabilities were to occur, the impact on the Company's results of operations could be significant. Also see Note 5 of Notes to the Consolidated Financial Statements. 30 Goodwill The Company has negative goodwill from prior acquisitions. Under generally accepted accounting principles in effect through December 31, 2001, these liabilities were accreted over their estimated useful lives. See Note 11 of Notes to the Consolidated Financial Statements. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK The following sections address the significant market risks associated with the Company's business activities as of December 31, 2001 and 2000. The Company's primary market risk exposures are foreign currency exchange risk and interest rate risk. With respect to the Company's investment portfolio, the risk management strategy is to place its investments with high credit quality issuers and to limit the amount of credit exposure with respect to particular ratings categories and any one issuer. The Company selects investments with characteristics such as duration, yield, currency and liquidity to reflect the underlying characteristics of related estimated claim liabilities. As of December 31, 2001, the Company's exposure to high yield investments was limited. While these investments are more susceptible to credit risk, their total market value represents approximately 6% of total investments and cash, and therefore management believes that the exposure to credit risk is not material. The Company has no derivatives and its investments do not contain terms that may result in potential losses due to leverage. Foreign Currency Exchange Rate Risk Foreign currency risk is the risk that the Company will incur economic losses due to adverse changes in foreign currency exchange rates. This risk arises from the Company's cash deposits denominated in foreign currencies. The Company's reinsurance operations have exposures to movements in various currencies, particularly the British pound sterling and Euro, as some of its business is denominated in those currencies. Therefore, changes in currency exchange rates affect the Company's balance sheet, statement of operations and statement of cash flows. Management estimates that a 10% immediate unfavorable change in each of the foreign currency exchange rates to which the Company is exposed at year end 2001 would have decreased the fair value of the Company's foreign denominated net assets by approximately $1.3 million. At year end 2000, the same 10% shift in foreign currency exchange rates would have resulted in a potential loss in fair value of approximately $2.8 million. Interest Rate Risk The Company's debt security investments are subject to interest rate risk. Increases and decreases in prevailing interest rates generally translate into decreases and increases in the fair value of debt security investments on the Company's outstanding variable rate debt. Additionally, the fair value of interest rate sensitive instruments may be affected by the creditworthiness of the issuer, a prepayment option, relative values of alternative investments, liquidity of the investment and other general market conditions. The Company monitors its sensitivity to interest rate risk by evaluating the change in its financial assets and liabilities relative to hypothetical increases and decreases in interest rates. It is assumed that the changes occur immediately and uniformly to each category of instrument containing interest rate risks. The hypothetical 31 changes in market interest rates reflect what could be deemed best or worst case scenarios. Significant variations in market interest rates could produce changes in the timing of repayments due to prepayment options available. The fair value of such instruments could be affected and therefore actual results might differ from those reflected in this summary. A 100 basis point increase in market interest rates would have resulted in an estimated pre-tax loss in the fair value of these instruments of $9.9 million and $31.1 million at year end 2001 and 2000, respectively. Similarly, a 100 basis point decrease in market interest rates would have resulted in an estimated pre-tax gain in the fair value of these instruments of $9.8 million and $28.2 million at year end 2001 and 2000, respectively. The Company has not experienced unrealized gains or losses to the extent indicated above. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information called for by this item can be found in the Consolidated Financial Statements and Notes thereto on pages F-1 - F-26. ITEM 9. CHANGES IN, AND DISAGREEMENTS WITH, ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Following the Trenwick/LaSalle business combination, the independent auditor for Trenwick was PricewaterhouseCoopers LLP and the independent auditor for the Company was Deloitte & Touche. Trenwick and the Company determined that it was in their best interest to utilize a single independent auditor. As a result, the Company determined not to retain Deloitte & Touche as the Company's independent auditor after the 1999 fiscal year. Instead, the Company decided to retain PricewaterhouseCoopers as its independent auditor. The decision to change independent auditors was approved by the Company's Board of Directors. The audit reports of Deloitte & Touche on the financial statements of the Company for the fiscal year ended and as of September 30, 1999 and for the three months ended and as of December 31, 1999 did not contain an adverse opinion or disclaimer of opinion or were qualified or modified as to uncertainty, audit scope, or accounting principles. During the Company's fiscal year ended September 30, 1999 and the interim period to December 22, 2000, there were no disagreements between Deloitte & Touche and the Company with respect to any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure. None of the reportable events described in Item 304(a)(1)(v) of Regulation S-K occurred with respect to the Company during the fiscal year ended September 30, 1999 and through the interim period to December 22, 2000. During the two most recent fiscal years and the subsequent interim period to December 22, 2000, neither the Company nor anyone on behalf of the Company consulted with PricewaterhouseCoopers regarding either the application of accounting principles to a specified transaction, either completed or proposed, or the type of audit opinion that might be rendered on the financial statements of the Company or any matter that was either the subject of a disagreement, within the meaning of Item 304(a)(1)(v) of Regulation S-K, or any reportable event, as that term is defined in Item 304(a)(1)(v) of Regulation S-K. 32 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS In connection with the Trenwick/LaSalle business combination, all of the external directors of LaSalle Re Holdings resigned their directorships and, in certain cases, became directors of Trenwick, leaving Guy Hengesbaugh as the sole director. Trenwick appointed a second director of the Company following the Trenwick/LaSalle business combination who resigned in January 2002. As such, Trenwick appointed James F. Billett, Jr. a director in January 2002. Guy D. Hengesbaugh aged 43 has been a director of the Company since February 2000. Mr. Hengesbaugh has been President and Chief Executive Officer of the Company since July 1, 1999. Prior to this he had served as President and Chief Operating Officer of the operating company, LaSalle Re, a position he had held since September 17, 1998. Mr. Hengesbaugh had served as Executive Vice President and Chief Underwriting Officer of the Company since its organization in September 1995 and Executive Vice President and Chief Underwriting Officer of LaSalle Re since its organization in October 1993. Prior to joining the Company, Mr. Hengesbaugh was with CNA in Chicago and London. Up to September 30, 1998, Mr. Hengesbaugh was an employee of CNA Bermuda and his services were made available to the Company pursuant to the Underwriting Services Agreement. Upon termination of this agreement, with effect from October 1, 1998, Mr. Hengesbaugh became an employee of the Company. James F. Billett, Jr., 58, has been a director of the Company since January 2002. Mr. Billett has served as Chairman of the Board and Chief Executive Officer of Trenwick since August 2000. Mr. Billett served as the Chairman of the Board and Chief Executive Officer of Trenwick Group Inc. and its predecessor from 1978 until the Trenwick/LaSalle business combination and served as President of Trenwick Group Inc. from 1988 until the Trenwick/LaSalle business combination. He is Chairman of the Executive Committee. Mr. Billett was formerly a Vice President of General Reinsurance Corporation. ITEM 11. EXECUTIVE COMPENSATION The following table sets forth, in summary form, the compensation earned by the CEO or a Named Executive Officer of the Company during the 2001 year. The 2001 and 2000 years ended December 31, 2001 and December 31, 2000, respectively. As the Company changed its fiscal year end following the Trenwick/LaSalle business combination, the 1999 period is for the year ended September 30, 1999. Mr. Stockton resigned from the Company in September 2001 and Ms. Moran resigned from the Company in January 2002.
Restricted Securities Name and principal Fiscal Other annual stock underlying All other position year Salary Bonus compensation awards(1) options compensation -------- ---- ------ ----- ------------ ------ ------- ------------ Guy D. Hengesbaugh Chief Executive Officer and 2001 468,900 -- 120,000(3) 224,992 31,690 51,575(4) President (effective 2000 450,000 386,364(2) 165,710(3) -- -- 56,376(4) July 1, 1999) 1999 412,500 477,273(2) 146,798(3) 109,626 -- 50,031(4) Mark C. Stockton Senior Vice President and Chief Underwriting 2001 283,250 -- 82,500(6) 74,997 10,563 18,883(7) Officer (effective 2000 275,000 115,227(5) 122,415(6) -- -- 27,500(7) July 15, 1999) 1999 240,000 157,045(5) 94,214(6) 21,262 -- 24,000(7) Clare E. Moran Senior Vice President and Chief Financial Officer (effective October 2001 162,000 -- 90,000(9) 51,929 7,313 16,200(10) 1, 2000) 2000 155,000 62,091(8) 85,053(9) -- -- 15,500(10)
33 (1) Amounts reflect restricted shares awarded as follows on March 1, 2001, based on the closing price per share on such date of $21.30: Mr. Hengesbaugh, 10,563 shares, Mr. Stockton, 3,521 shares, and Ms. Moran, 2,438 shares. The restricted shares vest in equal annual installments over five years from the date of award, beginning in 2002. Dividends are paid on restricted shares at the same rate as paid to all shareholders and, as permitted those amounts have not been included in this table On October 1, 1998, Mr. Hengesbaugh received a restricted stock award of 25,000 common shares. Mr. Hengesbaugh's award vests at the rate of 331/3% on the third, fourth and fifth anniversaries of the grant date. Dividends on these restricted shares were paid in additional shares of restricted stock, based on the closing price of a common share of the Company on the NYSE on the dividend payment date. Mr. Hengesbaugh received as dividends 446, 570 and 640 additional restricted shares on December 18, 1998, March 19, 1999 and June 18, 1999, respectively. During the 1999 fiscal year, Messrs. Hengesbaugh and Stockton and Ms. Moran received restricted stock awards as set forth below pursuant to the amended anti-dilution provisions of stock options granted on November 27, 1995 (the "1995 Options") and May 19, 1997 (the "1997 Options"). These restricted stock awards were made to compensate for the dilutive effect of certain dividends paid by the Company and vest only upon the exercise of the options to which they relate. The 1995 Options and 1997 Options vested in their entirety following the Trenwick/LaSalle business combination.
Number of shares Number of shares awarded awarded with respect with respect Name Date of award to the 1995 options to the 1997 options ---- ------------- ------------------- ------------------- Guy D. Hengesbaugh March 20, 1998 5,557 3,071 June 19, 1998 1,061 1,008 September 18, 1998 184 114 December 18, 1998 121 75 March 19, 1999 1,086 1,030 June 18, 1999 1,303 1,237 Mark C. Stockton December 18, 1998 -- 42 March 19, 1999 -- 572 June 18, 1999 -- 687 Clare E. Moran December 18, 1998 -- 16 March 19, 1999 -- 229 June 18, 1999 -- 275
The values shown in the Summary Compensation Table for all restricted stock awards, including any additional restricted shares awarded as dividends, have been calculated by multiplying the number of shares by the closing price of a common share of the Company on the NYSE on each grant or dividend date, as applicable. 34 The aggregate total of unvested restricted share holdings of each of the named executives as of December 31, 2001, at the then-applicable market price per share of $10.17 were: Unvested Name Restricted Shares Value ($) ---- ----------------- --------- Guy D. Hengesbaugh 53,076 539,782 Mark C. Stockton 0 0 Clare E. Moran 3,890 39,561 (2) Mr. Hengesbaugh earned a bonus of $136,364 under a cash incentive bonus agreement and an additional merit cash bonus of $250,000 for 2000. (3) Includes housing expenses of $120,000 for each of 2001, 2000 and fiscal 1999. (4) Consists of $46,575, $45,000 and $41,250 for monthly pension contributions for 2001, 2000 and 1999 respectively. For 2001, also includes $5,000 paid in respect of compensation consulting services. For 2000, also includes $6,376 for life insurance covering Mr. Hengesbaugh and $5,000 paid in respect of compensation consulting services. For fiscal 1999, also includes $6,681 for life insurance covering Mr. Hengesbaugh and $2,100 paid in respect of pension and compensation consulting services. (5) Mr. Stockton earned a bonus of $62,727 under a cash incentive bonus agreement and an additional merit cash bonus of $52,500 for 2000. (6) Includes housing expenses of $82,500 for 2001 and includes housing expenses of $76,500 for 2000. (7) Consists of $18,883 and $27,500 paid in connection with monthly pension contributions for 2001 and 2000, respectively. (8) Ms. Moran earned a bonus under a cash incentive bonus agreement of $ 34,091 for 2000. Ms. Moran also received a merit cash bonus of $28,000 for 2000. (9) Includes housing expenses of $90,000 for 2001 and includes housing expenses of $49,500 for 2000. (10) Consists of $16,200 and $15,500 paid in connection with monthly pension contributions for 2001 and 2000, respectively. 35 The following table sets forth information with respect to stock option grants to the named executives in 2001. The options, granted during 2001, to the named executives pursuant to Trenwick's equity incentive plans become exercisable in five equal annual installments beginning one year from the date of grant, but become immediately exercisable in full in the event of a change in control of Trenwick. They are subject to termination prior to their expiration date in the event of termination of the grantee's employment. Option Grants in Last Fiscal Year
Potential Realizable Value at Number of Percent of Total Assumed Annual Rates Securities Option/SARs of Stock Price Appreciation Underlying Granted to Exercise or for Option Term ($) Options/SARs Employees in Base Price Expiration ------------------- Name Granted (#) Fiscal Year (%) ($/Share) Date 5% 10% ----- ----------- --------------- --------- ---- --- --- Guy D. Hengesbaugh 31,690 5.0 21.30 03/01/11 425,248 1,073,245 Mark C. Stockton 10,563 1.7 21.30 03/01/11 141,744 357,737 Clare E. Moran 7,313 1.1 21.30 03/01/11 98,133 247,669
The following table sets forth information for each individual who served as the CEO or a named executive officer of the Company with regard to the number of Trenwick common shares underlying unexercised stock options and the value of such stock options at the end of the fiscal year. There were no unexercised stock appreciation rights for these in dividends. 2001 Year-End Option Values
Number of securities underlying unexercised Value of unexercised options/SARs in-the-money options/SARs at December 31, 2001 at December 31, 2001 Name Exerciseable/Unexerciseable Exerciseable/Unexerciseable ---- -------------------------- --------------------------- Guy D. Hengesbaugh 118,000/31,690 $0/$0 Mark C. Stockton 0/0 $0/$0 Clare E. Moran 20,000/7,313 $0/$0
Effective October 1, 1999, LaSalle entered into an amended employment agreement with Guy D. Hengesbaugh to reflect Mr. Hengesbaugh's promotion to the position of President and Chief Executive Officer. The agreement provides for automatic renewal on a daily basis, so that the remaining term of the agreement will always equal two years. If either party gives notice of termination, the agreement will expire two years after that notice is given. The agreement provides for an annual salary of $450,000 which effective March 1, 2001 was increased to $468,900. In addition, Mr. Hengesbaugh is entitled to an annual non-discretionary bonus based in part on the amount by which LaSalle Re's return on equity for that year exceeds 10% per annum, and is also eligible to receive a discretionary bonus. The agreement provides Mr. Hengesbaugh with various benefits, including disability and pension benefits, automobile allowance, club membership, housing and living allowance and reimbursement of reasonable business expenses. The agreement also includes a non-competition and non-solicitation covenant that will generally apply for a period of 12 months following the termination of Mr. Hengesbaugh's employment. Effective October 1, 1998, LaSalle entered into an employment agreement with Mark Stockton, who served as Senior Vice President and Chief Underwriting Officer until September, 2001. The agreement provided for automatic renewal on a daily basis, so that at the remaining term of the agreement will always equal one year. If either party gave notice of termination, the agreement expired one year after that notice was given. The 36 agreement provided for an annual base salary of $230,000, which effective March 1, 2001 was increased to $275,000 by action of Trenwick's Compensation Committee. In addition, Mr. Stockton was entitled to an annual non-discretionary bonus based in part on the amount by which LaSalle Re's return on equity for that year exceeded 10% per annum, and was also eligible to receive a discretionary bonus. The agreement provided Mr. Stockton with various benefits, including disability and pension benefits, automobile allowance, club membership, housing and living allowance and reimbursement of reasonable business expenses. The agreement also included a non-competition and non-solicitation covenant that generally applied for a period of 24 months following the termination of Mr. Stockton's employment. Mr. Stockton resigned from the Company in September 2001. Effective October 1, 1998, LaSalle entered into an employment agreement with Clare Moran, who served as Senior Vice-President, Treasurer and Chief Financial Officer. The agreement provided for automatic renewal on a daily basis, so that the remaining term of the agreement always equaled one year. If either party gave notice of termination, the agreement expired one year after that notice was given. The agreement provided for an annual base salary of $125,000, which effective March 1, 2001, was increased to $162,000 by action of Trenwick's Compensation Committee. In addition, Ms. Moran was eligible for a discretionary annual bonus. The agreement provided Ms. Moran with various benefits, including disability and pension benefits, automobile allowance, housing and living allowance and reimbursement of reasonable business expenses. The agreement also included a non-competition and non-solicitation covenant that generally applied for a period of 12 months following the termination of Ms. Moran's employment. Ms. Moran resigned from the Company in January 2002. Since the completion of the Trenwick/LaSalle business combination, the Company's directors have not been compensated for any services provided to LaSalle as a director. Since the completion of the Trenwick/LaSalle business combination, the Compensation Committee of the Board of Directors of Trenwick has established the compensation and compensation policies for Trenwick's subsidiaries, including the Company. The report of the Compensation Committee of the Board of Directors of Trenwick is incorporated herein by reference to the section captioned "Report of the Compensation Committee on the Compensation of Executive Officers of Trenwick" of Trenwick's proxy statement for its 2002 Annual General Meeting of Shareholders. In addition, since the completion of the Trenwick/LaSalle business combination, the Company's Common Shares are no longer registered under Section 12 of the Securities Exchange Act of 1934. Accordingly, no share price information is available to provide the basis for a performance graph. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The Company is a wholly owned subsidiary of Trenwick. The following table discloses the Chief Executive Officer's and the named executive officer's ownership in the Company's parent, Trenwick, at March 14, 2002.
Name of beneficial owner Number of Common Shares (1) Percentage of class ------------------------ --------------------------- ------------------- Guy D. Hengesbaugh(2) 140,067 * Mark C. Stockton 0 * Clare E. Moran(3) 20,000 * Directors and Executive officers as a Group 160,067 *
*Less than 1% 37 (1) Based on the most recent information available to the Company. Includes shares of restricted stock that would vest if the holder were to exercise certain options pursuant to which such restricted shares were granted as anti-dilution adjustments, which options are exercisable within 60 days of February 28, 2002. Also excludes 26,656 shares of restricted stock and dividend entitlements which were originally awarded to Mr. Hengesbaugh, on October 1, 1998, all of which will vest more than 60 days after March 14, 2002. (2) Includes options to purchase 124,338 common shares which are exercisable within 60 days of March 14, 2002. (3) Includes options to purchase 20,000 common shares which are exercisable within 60 days of March 14, 2002. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Underwriting services agreement and underwriting support services agreement Effective on October 1, 1998, the Company entered into an underwriting support services agreement (the "Underwriting Support Services Agreement") with CNA Re Services Company ("CRSC") and CNA Bermuda. Under the Underwriting Support Services Agreement, which expired on September 30, 2001, CRSC provided underwriting support services to the Company on a daily or hourly fee basis when and as requested by the Company. The Company paid CNA Bermuda a $333,333 annual retainer, which was credited against CRSC's daily or hourly fees and associated travel expenses. In recognition of the contribution made by CNA Bermuda to the development of the Company's business, the Company agreed, subject to certain conditions, to pay CNA Bermuda an underwriting profit commission of 1.67% of the aggregate net underwriting profits of LaSalle Re for each fiscal year during the term of the Underwriting Support Services Agreement for which the Company's loss ratio was 70% or less. While the current Underwriting Support Services Agreement did not terminate until September 30, 2001, the Company did not utilize the agreement since the Trenwick/LaSalle business combination. The Company accrued and expensed all fees payable under the agreement during the year ended December 31, 2000. This amounted to $786,000. Loan to an executive officer The Company loaned Mr. Hengesbaugh $142,321 in 2001 to finance a portion of the purchase price of a home in Bermuda. The loan is evidenced by a demand promissory note and interest is payable at the rate of 8% per annum. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K The following documents are filed as a part of this report: (a) Financial Statements and Schedules: 1. Financial Statements See Index to Financial Statements on page F-1 of this report, which is incorporated herein by reference. 38 2. Financial Statement Schedules: Schedule II - Condensed financial information of the registrant is filed with this document. All other schedules have been omitted since the required information is presented elsewhere in this report or is not applicable. 3. Exhibits
Exhibit Number Description Method of Filing ------ ----------- ---------------- 3.1 Memorandum of Association Incorporated by reference to Exhibit 3.1 to Registration Statement on Form S-1 (No. 33-97304) 3.2 Bye-Laws Incorporated by reference to Exhibit 3.2 to Form 10-Q for the quarterly period ended March 31, 1998 (File No. 1-12823) 10.1 Underwriting Support Services Agreement Incorporated by reference to Exhibit 10.7 to Form Dated October 1, 1998 among LaSalle Re, 10-K for the fiscal year ended September 30, CRSC and CNA Bermuda 1998 (File No. 1-12823) 10.2 Employment Agreement dated October 1, 1998 Incorporated by reference to Exhibit 10.12 to between Guy D. Hengesbaugh and LaSalle Re* Form 10-K for the fiscal year ended September 30, 1998 (File No. 1-12823) 10.3 Employment Agreement dated October 1, 1998 Incorporated by reference to Exhibit 10.12 to between Mark C. Stockton and LaSalle Re* Form 10-K for the fiscal year ended September 30, 1999 (File No. 1-12823) 10.4 Employment Agreement dated October 1, 1998 Incorporated by reference to Exhibit 10.6 to Form between Clare E. Moran and LaSalle Re* 10-K for the year ended December 31, 2000 (File No. 1-12823) 10.5 Amendment to Employment Incorporated by reference to Exhibit 10.7 to Form Agreement dated as of June 1, 1999 between 10-K for the year ended December 31, 2000 (File Clare E. Moran and LaSalle Re* No.1-12823) 10.6 Quota Share Arrangement, dated as of April 1, Incorporated by reference to Exhibit 10.2 to Form 1999, between LaSalle Re and Continental 10-Q for the quarterly period ended March 31, 1999 Casualty Company (File No. 1-12823) 10.7 Quota Share Treaty between CNA International Incorporated by reference to Exhibit 10.32 to Reinsurance Company Limited and LaSalle Re Form 10-K for the fiscal year ended September in respect of 1999 underwriting year of account 30, 1999 (File No. 1-12823) (London office) 10.8 Quota Share Treaty between CNA International Incorporated by reference to Exhibit 10.38 to Reinsurance Company Limited and LaSalle Re Form 10-K for the fiscal year ended September in respect of 1999 underwriting year of account 30, 1999 (File No. 1-12823) (Amsterdam office) 10.9 LMX Quota Share Retrocessional Agreement Incorporated by reference to Exhibit 10.43 to between Continental Casualty Company and Form 10-K for the fiscal year ended September 30, LaSalle Re for the 1999 underwriting year of 1999 (File No. 1-12823) Account
39
Exhibit Number Description Method of Filing ------ ----------- ---------------- 12.1 Statement re computation of ratio of earnings Incorporated by reference to Exhibit 12.1 to to combined fixed charges and preferred share Form 10-K for the fiscal year ended September 30, dividends 1999 16.1 Letter re change in certifying accountant Incorporated by reference to Exhibit 16 to Form 8-K filed on December 22, 2000 (File No. 1-12823) 21.1 Subsidiaries of the Registrant Incorporated by reference to Exhibit 21.1 to Registration Statement on Form S-1 (No. 333-14861)
* Management contract or compensatory plan or arrangement. (b) Reports on Form 8-K: The Company did not file any Current Reports on Form 8-K during the quarter ended December 31, 2001 40 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in Bermuda, on the18th day of March, 2002. LASALLE RE HOLDINGS LIMITED /S/ GUY D. HENGESBAUGH ---------------------- By Name: Guy D. Hengesbaugh Title: Director, President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed by the following persons on behalf of the Registrant and in the capacities indicated and on the 18th day of March 2002. Signature Title --------- ----- /S/ GUY D. HENGESBAUGH Director, President and Chief Executive ----------------------- Officer (Principal Executive officer and Guy D. Hengesbaugh Chief Financial Officer) /S/ JAMES F. BILLETT, JR. Director ------------------------- James F. Billett, Jr. 41 LASALLE RE HOLDINGS LIMITED INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page Number ------ INDEPENDENT AUDITORS' REPORTS ....................................... F-2 CONSOLIDATED BALANCE SHEETS ......................................... F-5 CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME .............................................................. F-6 CONSOLIDATED STATEMENTS OF CASH FLOWS ............................... F-7 CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY CONSOLIDATED STATEMENTS OF CASH FLOWS ........................ F-8 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS .......................... F-9 F-1 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Shareholders of LaSalle Re Holdings Limited In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations and comprehensive income, of changes in shareholders' equity and of cash flows present fairly, in all material respects, the financial position of LaSalle Re Holdings Limited and its subsidiaries at December 31, 2001 and 2000, and the results of its operations and its cash flows for each of the years then ended, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these financial statements in accordance with auditing standards generally accepted in the United States of America which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. PricewaterhouseCoopers Hamilton, Bermuda February 28, 2002 F-2 INDEPENDENT AUDITORS' REPORT The Board of Directors and Shareholders LaSalle Re Holdings Limited We have audited the consolidated balance sheet of LaSalle Re Holdings Limited and subsidiaries as of December 31, 1999 (not presented separately herein), and the related accompanying consolidated statements of operations and comprehensive loss, changes in shareholders' equity, and cash flows for the period from October 1, 1999 to December 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of LaSalle Re Holdings Limited and subsidiaries as of December 31, 1999 and the results of their operations and their cash flows for the period from October 1, 1999 to December 31, 1999 in conformity with accounting principles generally accepted in the United States of America. As discussed in Note 9, the accompanying 1999 financial statements were restated. Hamilton, Bermuda DELOITTE & TOUCHE November 10, 2000. F-3 INDEPENDENT AUDITORS' REPORT The Board of Directors and Shareholders LaSalle Re Holdings Limited We have audited the consolidated balance sheet of LaSalle Re Holdings Limited and subsidiaries as of September 30, 1999 (not presented separately herein), and the related accompanying consolidated statements of operations and comprehensive income, changes in shareholders' equity, and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of LaSalle Re Holdings Limited and subsidiaries as of September 30, 1999 and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. As discussed in Note 9, the accompanying 1999 financial statements were restated. Hamilton, Bermuda DELOITTE & TOUCHE November 5, 1999 (July 13, 2000 as to Note 9) F-4 LaSalle Re Holdings Limited Consolidated Balance Sheet (Amounts expressed in thousands of United States dollars, except share and per share data) December 31, 2001 and 2000 2001 2000 -------- -------- ASSETS: Debt securities available for sale, at fair value $507,278 $476,445 Cash and cash equivalents 36,431 23,221 Accrued investment income 12,192 14,770 Premiums receivable 86,227 77,242 Reinsurance recoverable balances 57,179 6,431 Prepaid reinsurance premiums 8,206 10,735 Deferred policy acquisition costs 4,933 7,616 Trenwick Group Ltd. advances 11,651 4,002 Trenwick Group Ltd. loan 75,000 75,000 Reinsurance deposits and other assets 3,223 30,033 -------- -------- Total assets $802,320 $725,495 ======== ======== LIABILITIES: Unpaid claims and claims expenses $280,487 $174,763 Unearned premium income 34,937 39,929 Reinsurance balances payable 24,892 21,561 Negative goodwill 11,585 12,073 Other liabilities 12,824 13,078 -------- -------- Total liabilities 364,725 261,404 -------- -------- SHAREHOLDERS' EQUITY: Series A preferred shares, $1.00 par value, 3,000,000 shares issued and outstanding, at liquidation value 75,000 75,000 Common shares, $1.00 par value, 20,432,043 shares issued and outstanding 20,432 20,432 Additional paid in capital 292,039 292,039 Retained earnings 45,320 70,628 Accumulated other comprehensive income 4,804 5,992 -------- -------- Total shareholders' equity 437,595 464,091 -------- -------- Total liabilities and shareholders' equity $802,320 $725,495 ======== ======== The accompanying notes are an integral part of these statements. F-5 LaSalle Re Holdings Limited Consolidated Statement of Operations and Comprehensive Income (Amounts expressed in thousands of United States dollars) Years Ended December 31, 2001 and 2000, Three Month Period Ended December 31, 1999 and Year Ended September 30, 1999
2001 2000 1999 1999 Year Year Period Year --------- --------- -------- --------- REVENUES: Net premiums earned $97,542 $108,096 $30,391 $126,615 Net investment income 38,928 37,444 8,588 33,847 Net realized investment gains (losses) 7,567 (1,688) -- 615 Negative goodwill accretion 488 122 -- -- --------- --------- -------- --------- Total revenues 144,525 143,974 38,979 161,077 --------- --------- -------- --------- EXPENSES: Claims and claims expenses incurred 122,981 80,586 46,642 131,147 Policy acquisition costs amortization 20,886 21,270 5,878 19,844 Underwriting expenses 11,790 13,342 4,533 13,733 General and administrative expenses -- 3,255 1,383 788 Interest expense -- 1,173 346 1,714 Foreign currency losses (gains) 113 244 28 (470) --------- --------- -------- --------- Total expenses 155,770 119,870 58,810 166,756 --------- --------- -------- --------- Income (loss) before minority interest (11,245) 24,104 (19,831) (5,679) Minority interest in subsidiary net income (loss) -- 839 (4,990) (2,845) --------- --------- -------- --------- Net income (loss) (11,245) 23,265 (14,841) (2,834) Preferred share dividends 6,563 6,563 1,641 6,563 --------- --------- -------- --------- Net income (loss) available to common shareholders $(17,808) $16,702 $(16,482) $(9,397) ========= ========= ======== ========= COMPREHENSIVE INCOME (LOSS): Net income (loss) $(11,245) $23,265 $(14,841) $(2,834) Other comprehensive income (loss): Net unrealized investment gains (losses) (1,188) 14,401 (3,429) (17,886) --------- --------- -------- --------- Comprehensive income (loss) $(12,433) $37,666 $(18,270) $(20,720) ========= ========= ======== =========
The accompanying notes are an integral part of these statements. F-6 LaSalle Re Holdings Limited Consolidated Statement of Cash Flows (Amounts expressed in thousands of United States dollars) Years Ended December 31, 2001 and 2000, Three Month Period Ended December 31, 1999 and Year Ended September 30, 1999
2001 2000 1999 1999 Year Year Period Year --------- --------- -------- --------- OPERATING ACTIVITIES: Premiums collected, net of acquisition costs $124,528 $113,228 $22,609 $114,315 Ceded premiums paid, net of acquisition costs (20,711) (26,009) (7,050) (21,326) Claims and claims expenses paid (68,838) (93,094) (12,048) (93,622) Claims and claims expenses recovered 617 11,263 531 1,985 Underwriting expenses paid (20,504) (23,721) 500 (13,736) --------- --------- -------- --------- Cash from (for) underwriting activities 15,092 (18,333) 4,542 (12,384) Net investment income received 37,044 34,128 5,756 34,828 Other income received, net of expenses 9 -- -- -- General and administrative expenses paid -- (3,255) (1,383) (788) Interest expense paid -- (1,173) (346) (1,714) --------- --------- -------- --------- 8,569 Cash from operating activities 52,145 11,367 8,569 19,942 --------- --------- -------- --------- INVESTING ACTIVITIES: Debt securities sales 288,365 257,462 49,980 305,671 Debt securities maturities 68,162 73,000 10,000 24,710 Debt securities purchases (381,399) (251,838) (62,430) (299,882) Trenwick Group Ltd. loan -- (75,000) -- -- --------- --------- -------- --------- Cash from (for) investing activities (24,872) 3,624 (2,450) 30,499 --------- --------- -------- --------- FINANCING ACTIVITIES: Common share sales -- 430 74 412 Share and option repurchases -- (3,176) -- (1,346) Equity put option premium payments -- (825) (611) (1,850) Preferred share dividends paid (6,563) (6,563) (1,641) (6,563) Common share dividends paid (7,500) (1,500) -- (37,533) --------- --------- -------- --------- Cash for financing activities (14,063) (11,634) (2,178) (46,880) --------- --------- -------- --------- Change in cash and cash equivalents 13,210 3,357 3,941 3,561 Cash and cash equivalents, beginning of period 23,221 19,864 15,923 12,362 --------- --------- -------- --------- Cash and cash equivalents, end of period $36,431 $23,221 $19,864 $15,923 ========= ========= ======== =========
The accompanying notes are an integral part of these statements. F-7 LaSalle Re Holdings Limited Consolidated Statement of Changes in Shareholders' Equity (Amounts expressed in thousands of United States dollars except share data) Years Ended December 31, 2001 and 2000, Three Month Period Ended December 31, 1999 and Year Ended September 30, 1999
2001 2000 1999 1999 Year Year Period Year --------- --------- --------- --------- Shareholders' equity, beginning of period $464,091 $361,960 $382,197 $430,053 Preferred and common shares: Common shares sold under employee stock purchase plans -- 247 37 300 Common shares issued on exercise of options and warrants -- 8 -- 660 Common shares issued under employee compensation plan -- 7 -- 81 Restricted common shares awarded -- -- -- 1,092 Common shares repurchased -- -- -- (1,097) Exercise of options to acquire shares in subsidiary -- 105 -- -- Compensation recognized under employee plans -- 243 22 4 Equity put option cost recognized, net of applicable minority interest -- (630) (469) (1,420) Minority interest change -- (684) 10 (1,068) Common share issued to acquire minority interest in subsidiary -- 77,863 -- -- Acquisition costs -- (1,596) -- -- Deferred compensation under share award plan Compensation deferred, net of applicable minority interest -- 310 -- (1,092) Compensation expense recognized, net of applicable minority interest -- 208 69 576 Acquisition of minority interest -- (73) -- -- Minority interest change -- 2 -- -- Retained earnings Net income (loss) (11,245) 23,265 (14,841) (2,834) Preferred share dividends declared (6,563) (6,563) (1,641) (6,563) Common share dividends declared (7,500) (1,500) -- (17,543) Shares repurchased on exercise of share options -- (2,439) -- (712) Minority interest change -- (176) 5 (289) Accumulated other comprehensive income Other comprehensive income (loss) (1,188) 14,401 (3,429) (17,886) Acquisition of minority interest -- (891) -- -- Minority interest change -- 24 -- (65) --------- --------- --------- --------- Shareholders' equity, end of period $437,595 $464,091 $361,960 $382,197 ========= ========= ========= =========
The accompanying notes are an integral part of these statements. F-8 LaSalle Re Holdings Limited Notes to Consolidated Financial Statements (Amounts expressed in thousands of United States dollars except share and per share data) Years Ended December 31, 2001 and 2000, Three Month Period Ended December 31, 1999 and Year Ended September 30, 1999 Note 1 Organization and Basis of Presentation Organization LaSalle Re Holdings Limited (the "Company") was incorporated on September 20, 1995 under the laws of Bermuda to act as an investment holding company. LaSalle Re Limited ("LaSalle Re") was incorporated on October 26, 1993 under the laws of Bermuda and commenced operations on November 22, 1993. LaSalle Re is licensed under the Insurance Act, 1978 as amended by the Insurance Amendment Act, 1995 of Bermuda to write insurance business and operates as a multi-line reinsurance company, with emphasis on property catastrophe business. On August 26, 1994, LaSalle Re incorporated a subsidiary company in the United Kingdom, to act as a representative office for the Company. In addition, on June 11, 1996, LaSalle Re incorporated a subsidiary company in Bermuda, to provide capital support to selected Lloyd's syndicates. Following the Trenwick/LaSalle business combination, the Company closed its UK representative office and ceased to actively participate as a corporate member in Lloyd's. On September 27, 2000, the Company completed a business combination with Trenwick Group Ltd. ("Trenwick") and Trenwick Group Inc. Under the terms of the business combination, the common shareholders of the Company, Trenwick, Trenwick Group Inc., and the minority shareholders of LaSalle Re Limited exchanged their shares on a one-for-one basis for shares in Trenwick. Following this transaction, the Company became a wholly owned subsidiary of Trenwick. In connection with the business combination, the Company changed its year end from September 30 to December 31 to be consistent with Trenwick. Consequently, the data presented in these financial statements is for the twelve months ended December 31, 2001, December 31, 2000, the three months ended December 31, 1999 and the twelve months ended September 30, 1999. Basis of presentation We include the accounts of LaSalle Re Holdings Limited and its subsidiaries in these financial statements after elimination of significant inter-company accounts and transactions. We have reclassified certain items in prior financial statements to conform to current presentation. We prepared these consolidated financial statements in conformity with accounting principles that are generally accepted in the United States of America, sometimes referred to as U.S. GAAP. In preparing these financial statements, we are required 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, as well as the reported amounts of revenues and expenses during the reporting periods. Actual amounts will differ from these estimates. We translate foreign currency monetary assets and liabilities at the rates of exchange at the balance sheet dates. We translate foreign currency revenues and expenses at the exchange rates in effect at the date of the transaction. We include exchange gains and losses in net income as they arise. F-9 We accounted for the business combination between the Company, Trenwick Group Inc. and LaSalle Re as a purchase by the Company of the minority interest in LaSalle Re. Accordingly in these financial statements we have eliminated the minority interest in net income of LaSalle Re from October1, 2000. Other significant accounting policies are presented in italics within the appropriate footnotes. Note 2 Business Combinations As described above, following shareholder and regulatory approval, Trenwick issued 36,668,599 of its common shares on a one-for-one, tax-free basis to the former shareholders of the Company (15,634,394 shares, including 26,656 restricted shares issued under share award plans), the minority shareholders of LaSalle Re, then a 77.5% owned subsidiary of the Company (4,797,649 shares), and the former shareholders of Trenwick Group Inc. (16,236,551 shares, including 224,331 restricted shares issued under share award plans). We accounted for the acquisition of the minority interest in LaSalle Re as a purchase. Under the purchase basis of accounting, we allocated the purchase price ($77,207) to the identifiable assets acquired and liabilities assumed, based on their estimated fair values at the date of acquisition and recorded the overallocated excess ($12,196) as negative goodwill. Pending changes in accounting for negative goodwill and its accretion are described in Note 11. Note 3 Segment And Geographic Information Segment Information The Company conducts its business in two segments: worldwide property catastrophe reinsurance and Lloyd's syndicates. The worldwide property catastrophe reinsurance segment, which is written in Bermuda, provides reinsurance for property catastrophe and for other lines of business, which have similar characteristics, namely high severity and low frequency. The Lloyd's syndicates are in runoff. The following tables present business segment financial information for the Company at year end 2001 and 2000 and for the other periods presented: 2001 2000 Total assets: Year Year -------- -------- Worldwide property catastrophe reinsurance $765,697 $658,448 Lloyd's syndicates 36,623 67,047 -------- -------- Total assets $802,320 $725,495 ======== ========
2001 2000 1999 1999 Year Year Period Year --------- --------- -------- --------- Total revenues: Worldwide property catastrophe reinsurance $128,455 $120,470 $35,855 $147,808 Lloyd's syndicates 16,070 23,504 3,124 13,269 --------- --------- -------- --------- Total revenues $144,525 $143,974 $38,979 $161,077 ========= ========= ======== ========= Net income (loss): Worldwide property catastrophe reinsurance $(593) $33,279 $(13,576) $755 Lloyd's syndicates (10,652) (10,014) (1,265) (3,589) --------- --------- -------- --------- Net income (loss) $(11,245) $23,265 $(14,841) $(2,834) ========= ========= ======== =========
F-10 Geographic Information The following table presents the Company's gross premiums written allocated to the geographic region in which the risks originate:
2001 2000 1999 1999 Year Year Period Year -------- -------- ------- -------- Gross premiums written: United States $62,429 $51,385 $719 $60,074 United Kingdom 14,301 35,615 3,337 32,161 Europe, excluding United Kingdom 10,823 4,821 -- 9,555 Australia, New Zealand and Far East 16,498 7,872 647 7,383 Worldwide 41,481 30,470 5,604 29,837 -------- -------- ------- -------- Gross premiums written $145,532 $130,163 $10,307 $139,010 ======== ======== ======= ========
Note 4 Underwriting Activities Premiums We estimate premiums written based upon reports received from ceding companies. We adjust these estimates when a contract contains a no claims bonus with a provision for the return premium recorded simultaneously with the written premium. In addition, we review estimates with adjustments recorded in the period in which the actual amounts are determined. We recognize reinstatement premiums at the time a loss occurs when coverage is reinstated. We earn premiums on property catastrophe excess of loss contracts on a pro rata basis over the period the coverage is provided, which is generally 12 months. Under pro rata property catastrophe contracts, the risks underlying the contracts incept throughout the policy period and premiums generally are earned over an 18 month period. We estimate premiums written for LaSalle Re Corporate Capital Ltd. from reports submitted to the Company by the syndicates. We earn these premiums in accordance with the related underlying risk attachment periods, which average between 18-24 months. We earn reinstatement premiums over the remaining life of the contract. Unearned premiums represent the portion of premiums written which are applicable to the unexpired terms of the policies in force. The components of premiums written and earned are as follows: 2001 2000 1999 1999 Year Year Period Year --------- --------- -------- --------- Assumed premiums written $145,532 $130,163 $10,307 $139,010 Ceded premiums written (50,453) (31,631) (897) (28,191) --------- --------- -------- --------- Net premiums written $95,079 $98,532 $9,410 $110,819 ========= ========= ======== ========= Assumed premiums earned $150,524 $140,129 $37,460 $145,080 Ceded premiums earned (52,982) (32,033) (7,069) (18,465) --------- --------- -------- --------- Net premiums earned $97,542 $108,096 $30,391 $126,615 ========= ========= ======== ========= Policy Acquisition Costs Policy acquisition costs primarily consist of commissions and brokerage expenses incurred at policy or contract issue date. These costs vary with and are primarily related to the acquisition of business. We defer and amortize policy acquisition costs over the period in which the related premiums are earned. We periodically review deferred policy acquisition costs to determine that they do not exceed recoverable amounts after allowing for anticipated investment income. F-11 The components of policy acquisition costs are as follows:
2001 2000 1999 1999 Year Year Period Year -------- -------- ------ ------- Gross policy acquisition costs deferred $18,317 $21,379 $9,319 $21,317 Ceded policy acquisition costs deferred (114) (963) -- -- -------- -------- ------ ------- Net policy acquisition costs deferred $18,203 $20,416 $9,319 $21,377 ======== ======== ====== ======= Policy acquisition costs Expensed $20,886 $21,270 $5,878 $19,844 ======== ======== ====== =======
Claims and Claims Expenses We record claims and claims expenses as incurred so as to match claims and claims expense costs with premiums over the contract periods. The amount provided for unpaid claims and claims expenses consists of any unpaid reported claims and claims expenses and estimates for incurred but not reported claims and claims expenses, net of salvage and subrogation. The estimates for claims and claims expenses incurred but not reported are developed based on industry information, contract reviews, historical claims and claims expense experience and an actuarial evaluation of expected claims and claims expense experience. Any adjustments to these estimates are reflected in income when known. The amount included as claims incurred in respect of business written by LaSalle Re Corporate Capital Ltd. is derived from an analysis of expected loss ratios.. Given the inherent nature of major catastrophic events, considerable uncertainty underlies the assumptions and associated estimated reserves for claims and claims expenses. We review these estimates and, as experience develops and new information becomes known, the reserves are adjusted as necessary. We reflect such adjustments, if any, in results of operations in the period in which they are determined and account for as changes in estimates. Due to the inherent uncertainty in estimating the liability for claims and claims expenses, there can be no assurance that the ultimate liability will not exceed recorded amounts, with a resulting material effect on the Company. We believe based on the current information available used in estimating the liability, that the Company's recorded amount is adequate to meet its future obligations. The components of net claims and claims expenses incurred are as follows:
2001 2000 1999 1999 Year Year Period Year --------- ------- -------- --------- Gross claims and claims expenses incurred $174,347 $79,973 $55,849 $142,232 Ceded claims and claims expenses incurred (51,366) 613 (9,207) (11,085) --------- ------- -------- --------- Net claims and claims expenses incurred $122,981 $80,586 $46,642 $131,147 ========= ======= ======== =========
The following table presents a reconciliation of the beginning and ending balances of net liabilities for unpaid claims and claims expenses. The gross liabilities for unpaid claims and claims expenses at period ends are as reflected in the balance sheet. The net liabilities for unpaid claims and claims expenses are after deductions for reinsurance recoverable on unpaid claims and claims expenses, also as reflected in the balance sheet. F-12
2001 2000 1999 1999 Year Year Period Year --------- --------- --------- --------- Net unpaid claims and claims expenses, beginning of period $168,332 $172,576 $137,452 $97,942 --------- --------- --------- --------- Provision, net of reinsurance recoverable: Claims incurred in the current period 121,981 60,149 50,244 82,537 Claims incurred prior to the current period 1,000 20,437 (3,602) 48,610 --------- --------- --------- --------- Total provision 122,981 80,586 46,642 131,147 --------- --------- --------- --------- Payments, net of reinsurance: Claims incurred in the current period (7,824) (6,374) (899) (12,821) Claims incurred prior to the current period (60,397) (78,456) (10,619) (78,816) --------- --------- --------- --------- Total payments (68,221) (84,830) (11,518) (91,637) --------- --------- --------- --------- Foreign currency translation adjustment to Net unpaid claims and claims expenses 216 -- -- -- --------- --------- --------- --------- End of period: Net unpaid claims and claims expenses 223,308 168,332 172,576 137,452 Reinsurance recoverable on unpaid claims and claims expenses 57,179 6,431 17,776 9,100 --------- --------- --------- --------- Gross unpaid claims and claims expenses $280,487 $174,763 $190,352 $146,552 ========= ========= ========= =========
The increase in the Company's incurred claims were primarily the result of losses relating to the September 11th terrorist attacks. There was minimal prior year development on a net basis in 2001. Adverse development associated with Lloyd's syndicates segment was off set by favorable development on catastrophic large losses which occurred prior to 2001. The prior year development for the 2000 year was due primarily to additional incurred claims from European Storms Martin and Anatol. Both of these storms occurred in December 1999. The increase in the Company's incurred claims followed an increase in the market estimate of the size of the insured claims. This was due to new information emerging following the elapse of time from the date of loss. The favorable development on prior period claims reserves for the 1999 period related primarily to a reduction in the claims emanating from an earthquake in Turkey. This was due to a reduction in the size of industry estimates relating to the loss which were used to originally estimate the Company's potential incurred loss. The prior year development for the 1999 year was due to several factors. Firstly, the Company increased reserves by $14,500 in respect of Hurricane Georges, which occurred in September 1998. This followed an increase in the size of the market loss. Secondly, in March 1999, the Company recorded outstanding claim reserves totaling approximately $11,000 on three stop loss contracts. These claims arose out of two industry issues relating to extended warranty business and the deterioration of the Lloyd's motor insurance market. This business produced loss emergence significantly higher than both the Company and the industry would have expected. These causes could not have been reasonably anticipated when incurred but not reported claims were previously established. Thirdly, as a result of higher than previously anticipated claims on international catastrophe business, the Company strengthened its incurred but not reported claims F-13 by approximately $16,000 to reflect this trend. This methodology was continued going forward when establishing estimates. Reinsurance We enter into reinsurance and retrocessional agreements to reduce our exposure on large catastrophic losses. We expense reinsurance premiums on a pro-rata basis over the period the coverage is provided. We classify reinsurance contracts, which do not meet insurance accounting risk transfer requirements as deposits. We treat these deposits as financing transactions and credit or charge interest income or interest expense to them according to contract terms. We pay reinstatment premiums on certain reinsurance and retrocessional agreements when a catastrophic event occurs to reinstate coverage over the remaining life of the contract. In 2001, the Company has purchased three excess of loss programs which provide coverage of $20,000 in excess of the first $30,000 of losses per occurrence, and $5,000 in excess of the first $50,000 of losses per occurrence and $25,000 in excess of the first $75,000 of losses per occurrence. During 1999 and 2000, the Company purchased an excess of loss reinsurance program which provided various limits for first, second and third loss occurrences. This contract was cancelled effective December 31, 2000. In addition, the Company had a quota share arrangement which ceded a proportion of the Company's property catastrophe business to a founding shareholder (see Note 13). The Company has also purchased other non-proportional excess of loss protections, which provide for the recovery of losses from reinsurers in excess of certain retentions and loss warranties. Reinsurance recoverable balances The components of reinsurance recoverable balances at year end 2001 and 2000 are as follows: 2001 2000 ------- ------ Paid claims $ -- $ 311 Unpaid claims and claims expenses 57,179 6,120 ------- ------ Reinsurance recoverable balances $57,179 $6,431 ======= ====== There was no allowance for doubtful accounts on reinsurance recoverable balances at year end 2001 or 2000. Reinsurance agreements provide for recovery of a portion of certain claims and claims expenses from reinsurers. The Company remains liable in the event that the reinsurer is unable to meet its obligation. See Note 13 for further details. F-14 Note 5 Investing Activities Debt Security Investments We have classified debt securities as "available for sale" and reported them at estimated fair value using quoted market prices or broker dealer quotes. Fair value and amortized cost or cost of debt securities at year end 2001 and 2000 follow:
2001 2000 ----------------------- ----------------------- Fair Fair Value Cost Value Cost -------- -------- -------- -------- U.S. and U.K. federal government securities, including agencies $ 54,869 $ 52,803 $100,890 $ 98,910 Other foreign government securities 25,186 24,448 57,629 56,660 Mortgage and other asset-backed securities 119,411 117,991 -- -- Corporate and other debt securities 307,812 307,232 317,926 314,883 -------- -------- -------- -------- Debt securities fair value and amortized cost $507,278 $502,474 $476,445 $470,453 ======== ======== ======== ========
Certain of the Company's investments are pledged as security for letters of credit. See Note 6. Gross unrealized gains and losses on debt securities at year end 2001 and 2000 follow:
2001 2000 ---------------------- --------------------- Gains Losses Gains Losses ------- ------- ------ ------- U.S. and U.K. federal government securities, including agencies $ 2,066 -- $2,092 $ (112) Other foreign government securities 738 -- 1,111 (142) Mortgage and other asset-backed securities 1,444 (24) -- -- Corporate and other debt securities 7,235 (6,655) 5,174 (2,131) ------- ------- ------ ------- Debt securities gross gains and losses $11,483 $(6,679) $8,377 $(2,385) ======= ======= ====== =======
The fair value and amortized cost for debt securities are shown below by contractual maturity periods, except mortgage-backed and asset-backed securities which are included based on expected maturity dates. Actual maturities will differ from contractual maturities because borrowers generally have the right to prepay obligations. Amortized Fair Value Cost ------------ --------- Due in one year or less $ 74,539 $ 73,125 Due after one year through five years 301,211 292,821 Due after five years through ten years 74,569 74,416 Due after ten years 56,959 62,112 -------- -------- Debt securities total maturities $507,278 $502,474 ======== ======== Net Investment Income and Net Investment Gains (Losses) We recognize investment income, consisting principally of interest, when earned, net of investment expenses. In computing interest income, we amortize premiums and accrete discounts on debt securities utilizing the interest method. We adjust the amortization and accretion for mortgage-backed and other asset-backed securities, when sufficient information exists to F-15 estimate the probability and timing of their prepayments, to the amount that would have existed had the new effective yield been applied since the acquisition of the security. We generally limit investments in debt securities that are rated below investment grade, as these investments are subject to a higher degree of credit risk than investment grade securities. We monitor the creditworthiness of the portfolio, including below investment grade securities, and we write down investments when fair values decline for reasons other than changes in interest rates or other perceived temporary conditions. We determine realized gains or losses on disposition of investments on the basis of specific identification. Sources of net investment income follow:
2001 2000 1999 1999 Year Year Period Year -------- -------- ------- -------- Debt securities interest $31,224 $28,007 $6,100 $26,299 Cash and cash equivalents interest 1,104 7,546 2,332 6,477 Intercompany investment income 4,688 -- -- -- Other investment income 2,548 2,805 375 1,937 -------- -------- ------- -------- Gross investment income 39,564 38,358 8,807 34,713 Other investment expenses (636) (914) (219) (866) -------- -------- ------- -------- Net investment income $38,928 $37,444 $8,588 $33,847 ======== ======== ======= ========
Net realized gains (losses) on sales of investments and their effect on net income follow: 2001 2000 1999 Year Year Year ------- ------- ------- Debt securities realized gains $7,840 $538 $4,082 Debt securities realized losses (273) (2,226) (3,467) ------- ------- ------- Net realized investment gains (losses) 7,567 (1,688) 615 Applicable minority interest -- (450) 144 ------- ------- ------- Net realized investment gains (losses) included in net income $7,567 $(1,238) $471 ======= ======= ======= The Company did not write down the value of any securities during the 2001 and 2000 years, the 1999 period or the 1999 year as any declines were viewed to be temporary. Net unrealized gains (losses) on investments and their effect on other comprehensive income (loss) follow:
2001 2000 1999 1999 Year Year Period Year ------- -------- ------- -------- Debt securities net gains (losses) $6,379 $12,197 $(4,471) $(22,684) Applicable minority interest -- 966 1,042 5,269 ------- -------- ------- -------- Net investment gains (losses) included in comprehensive income 6,379 13,163 (3,429) (17,415) Less net realized investment gains (losses) included in net income (loss) 7,567 (1,238) -- 471 ------- -------- ------- -------- Net unrealized investment gains (losses) included in other comprehensive income (loss) $(1,188) $14,401 $(3,429) $(17,886) ======= ======== ======= ========
F-16 Net Unrealized Investment Gains We calculate unrealized investment gains (losses) as the difference between recorded values (fair value) and amortized cost or cost. We include net unrealized investment gains and losses, in shareholders' equity as accumulated other comprehensive income. Note 6 Financing Activities Letters of Credit In the normal course of reinsurance operations, the Company's bankers have issued letters of credit totaling $72,138 at year end 2001 in favor of ceding insurance companies to secure the Company's obligations under various reinsurance contracts. In connection with the support of three Lloyd's syndicates, the Company has posted letters of credit in the amount of $14,255 at year end 2001. At year end 2001, $99,351 of debt securities were pledged as collateral for these letters of credit. Minority interest Prior to the Trenwick/LaSalle business combination, the minority interest disclosed in the financial statements represented founding shareholders' ownership of exchangeable non-voting shares in LaSalle Re. These shares were held by certain founding shareholders who would otherwise have held, or caused another shareholder to hold, directly, indirectly or constructively, in excess of 9.9% of the voting power of the Company or LaSalle Re. The exchangeable non-voting shares in LaSalle Re were exchangeable, at the option of the holder, for common shares of the Company, on a one-for-one basis, unless the board of directors of the Company determined such exchange would cause actual or potential adverse tax consequences to the Company or any shareholder. The exchangeable non-voting shares at all times ranked as to assets, dividends and in all other respects on a parity with the common shares of LaSalle Re, except that they did not have the right to vote on any matters except as required by Bermuda law and in connection with certain actions by the Company. Share Capital At year end 2001, the authorized share capital of Company was 100,000,000 shares of par value $1.00 each, which includes both preferred and common shares. At year end 2001 and 2000, the Company had 3,000,000 Series A preferred shares and 20,432,043 common shares which were fully paid, issued and outstanding. The preferred shares have a par value of $1.00 per share and are entitled to a liquidation preference of $25.00 per share ($75,000 aggregate). Under certain circumstances, the preferred shares may be redeemed in whole at a redemption price of $26.00 per share ($78,000 aggregate). Dividends on the preferred shares, are cumulative at 8.75% of the liquidation preference per annum ($2.1875 per share). On or after March 27, 2007, the preferred shares may be redeemed, in whole or in part, at a redemption price of $25.00 per share; if redeemed before this date, the Company will have to pay a premium. Shareholder stock options Prior to the Trenwick/LaSalle business combination, the Company had issued options to purchase common shares to certain shareholders and their affiliates and LaSalle Re had issued options to purchase exchangeable non-voting shares. These options became exerciseable on October 1, 1996 and were exerciseable until November 22, 2003. As the options were granted to certain of the founding shareholders and their affiliates as an inducement to purchase stock in LaSalle Re, no compensation expense has been recorded in connection with the options. During the 2000 year, a total number of 27,270 options to purchase exchangeable non-voting shares were exercised for cash and 81,308 in cashless transactions resulting in the issuance of 80,678 F-17 common shares. In addition 454,500 exchangeable non-voting shares were repurchased at a value of $6.89. There were no outstanding options at year end 2000. Catastrophe Equity Put The Company entered into a multi-year Catastrophe Equity Put in July 1997, which was renewed through December 2000. The CatEPut enabled the Company to exercise an option to raise equity through the insurance of convertible preferred shares at pre-negotiated terms, in the event of a major catastrophe or series of large catastrophes that cause substantial losses to the Company or its subsidiaries. On January 1, 2001, the publicly traded entity Trenwick assumed the benefits and obligations attaching to the CatEPut. Accordingly, although the CatEPut will be triggered by loss experience at the Company, the capital will be received by Trenwick. The CatEPut triggers remained the same but the value of the securities issuable upon its exercise was reduced to $55,000. Note 7 Income Taxation The Company is incorporated under the laws of Bermuda and is subject to Bermuda taxation. Under current Bermuda law, it is not required to pay any income or capital gains taxes in Bermuda. Furthermore, they have received an undertaking from the Bermuda Minister of Finance that, in the event of any income or capital gains taxes being imposed, they will be exempt from those taxes until 2016. Other than with respect to its Lloyd's business, the Company does not consider itself to be engaged in a trade or business in the United States and accordingly does not expect to be subject to United States income taxes. A Bermuda subsidiary is a corporate member of Lloyd's. Pursuant to a Closing Agreement between Lloyd's and the U.S. Internal Revenue Service, the subsidiary will be treated as engaged in business in the U.S. and is subject to U.S. corporate income tax on its net income from U.S. sources. The Company believes that currently there is no income tax liability. The Bermuda subsidiary is also subject to U.K. corporation tax, with the assessment made at the end of thirty-six months. Deferred tax assets and liabilities resulting from the Company's support of syndicates through LaSalle Re Corporate Capital are currently insignificant, but are subject to change as the results of the syndicates are uncertain. Note 8 Employee Benefits and Compensation Arrangements Retirement Plans We recognize expenses for employee retirement plans as they are incurred. The Company has a defined contribution plan for its full-time employees; the plan is administered by an independent life insurance company. The Company contributes 10% of an eligible employee's total compensation to the plan; employee contributions can be made to the plan subject to a maximum of 10% of the employee's total compensation. The Company's expenses for employee retirement plans for the 2001 and 2000 years, and the 1999 period and year were $378, $287, $33, $200, respectively. Restricted Common Share Awards We recorded deferred compensation for the fair value of restricted common share awards and presented deferred compensation as a separate, offsetting component of shareholders' equity. We recognized compensation expense over the vesting period of the restricted common shares. The only awards of restricted stock were granted during the 1999 year. The Company granted two separate awards of restricted stock to certain executive officers. The first vested over 5 years from F-18 the date of award with 33-1/3% vested on the third anniversary date of the award date, 66-2/3% vested on the fourth anniversary date of the award and 100% vested on the fifth anniversary date of the award. The second award of restricted stock vested ratably in two annual installments over 2 years from the date of award. During the restricted period the employee received dividends in the form of additional shares of restricted stock. Following the completion of the Trenwick/LaSalle business combination on September 27, 2000 all outstanding restricted common stock in the Company was exchanged for common stock in Trenwick and the associated deferred compensation at that time was offset against additional paid in capital. Employee Share Purchase Plan We recorded shares sold to employees in connection with employee share purchase plans at fair value; we recognized compensation expense for the difference between fair value and the discounted sales price. On September 27, 2000 following the Trenwick/LaSalle business combination, the Company's Employee Stock Purchase Plan (the "Plan") was cancelled. Under the Plan, the Company was authorized to sell up to 150,000 common shares at a discount equivalent to 15% of the market price, to employees of the Company, related companies, directors of the Company and other persons providing services to those companies. The maximum investment by an employee under the payroll deduction component of the Plan was $50 per calendar year. In addition, certain employees were eligible to use up to 100% of their annual bonus to purchase common shares under the Plan. Prior to cancellation, LaSalle Re Holdings issued 21,532, 3,390 shares and 19,459 shares, respectively, under the plan during the 2000 year, and the 1999 period and year, and recognized $47, $7 and $59, respectively, of compensation expense. Share Options We granted options for a fixed number of common shares to employees and non-employee directors. These options had an exercise price equal to the market value of the shares at the date of grant. The current accounting standard establishes a fair value based method of accounting for stock-based compensation plans; however, it permits an entity to continue to apply the accounting provisions of a previous standard and make pro forma disclosures of net income and earnings per share, as if the fair market value based method had been applied. We continued to account for the share option grants in accordance with the previous standard and have included the pro forma disclosures required by the fair value based method below. All options granted vested ratably in five annual installments over 5 years from the grant date and could be exercised over a 10-year period, commencing on the vesting date except for 85,218 options granted in 1997 which vested ratably in three annual installments from the date of grant. All outstanding options originally granted in 1995 and 1997, which totaled 295,436, automatically vested upon the completion of the Trenwick/LaSalle business combination. For certain option grants, there was an anti-dilution provision, which awarded the option holder a number of shares of restricted stock in the event that a dividend, when added to the value of all cash dividends previously paid within the same fiscal year, exceeded 5% of the average book value per share for the prior four quarters. For the 2001 and 2000 year and the 1999 period, no shares of restricted stock were awarded. For the 1999 year, 46,459 shares of restricted stock were awarded. For the 2000 year, the 1999 period and the 1999 year, the Company recorded compensation expense on these options of $317, $27 and $565, respectively. F-19
2000 1999 1999 Year Period Year -------- ---------- -------- Number of shares: Options outstanding, beginning of period 459,436 466,436 401,436 Options granted -- -- 233,000 Options canceled -- (7,000) (148,200) Options exercised -- -- (19,800) Options transferred to Trenwick (459,436) -- -- -------- ---------- -------- Options outstanding, end of period -- 459,436 466,436 ======== ========== ======== Options exercisable, end of period -- 237,986 168,943 ======== ========== ======== Range of exercise price: Options granted -- -- $19 - $26 Options exercised -- -- $19 - $20 Options outstanding, end of period -- $19 - $32 $19 - $32 Options exercisable, end of period -- $19 - $32 $19 - $32 ======== ========== ======== Weighted average exercise price: Options granted -- -- $23.87 Options exercised -- -- $19.25 Options outstanding, end of period -- $24.89 $24.90 Options exercisable, end of period -- $24.10 $24.39 ======== ========== ========
Pro Forma Information All of the outstanding share options were issued at an exercise price equal to fair market value on the date of grant; therefore no compensation expense has been recognized for these grants. Had the fair value based method described above been applied, net income (loss) would have been the pro forma amounts shown below:
2000 Year 1999 Period 1999 Year --------- ----------- --------- Net income (loss) available to common shareholders: As reported $(23,265) $(14,841) $(2,834) ======== ======== ======= Pro forma $(23,419) $(14,944) $(3,458) ======== ======== =======
The pro forma adjustments relating to options granted from 1995 to 2000 are based on a fair value method using the Black-Scholes option pricing model; no effect has been given to options granted prior to 1995. The Black-Scholes option valuation model was developed for use in estimating the fair value of options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected share price volatility. Because the Company's share options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate. Stock Appreciation Rights Under a plan now terminated, we recorded a liability for stock appreciation rights at each period end based on the excess of the current fair value of the underlying common stock over the fair value at the time of grant. We recognized compensation expense for adjustments to the liability. F-20 In consideration for entering into an employment agreement, the Company granted stock appreciation rights ("SAR's") to its former chairman and chief executive officer. The number of SAR's was dependent upon the financial performance of the Company over a set period of time and the value of each was dependent upon the fair market value of a common share. Following the exchange of shares in connection with the Trenwick/LaSalle business combination, the value of each SAR became dependent upon the fair market value of Trenwick's publicly traded common stock, therefore the liability was assumed by Trenwick. For the 2000 year, the 1999 period and the 1999 year, the Company (decreased) increased the total liability by ($964), $242 and ($1,490) respectively. Note 9 Earnings Per Share Common Share As of September 27, 2000, the Company became a wholly owned subsidiary of Trenwick. As the Company no longer has publicly held common shares, it no longer presents earnings per common share. Note 10 Insurance Regulation LaSalle Re, the Company's insurance subsidiary, is subject to Bermuda insurance regulations, which mandate minimum solvency margins and liquidity ratios. LaSalle Re must maintain a minimum statutory capital and surplus level of the greater of $100,000, 50% of net premiums written ($47,478 for 2001), or 15% of net loss reserves ($33,496 at year end 2001). In addition, Bermuda insurance regulations restrict the payment of dividends from retained earnings or additional paid-in-capital which exceed certain thresholds without prior approval from the Bermuda Minister of Finance. At year end 2001, there were no restrictions on the distribution of retained earnings. Statutory capital and surplus of LaSalle Re was $430,463 and $453,766 at year end 2001 and 2000, respectively; statutory net income (loss) was $(13,757), $9,992 and $(7,013) for the 2001 year, the fifteen months ended December 31, 2000 and the 1999 year, respectively. Note 11 Negative Goodwill Negative goodwill represents the unamortized excess of the fair value over the purchase price of identifiable net assets of acquired entities. Through the 2001 year, we accreted negative goodwill on a straight-line basis over twenty-five years. In July 2001, the Financial Accounting Standards Board issued a statement covering goodwill which is required to be adopted at the beginning of 2002. The new statement changes the income statement recognition of negative goodwill from a periodic accretion method to an immediate recognition approach. Implementation of this statement will result in a cumulative effect in a change of accounting principle. Note 12 Fair Value of Financial Instruments We define the fair value of a financial instrument as the amount at which the instrument could be exchanged in a current transaction between willing parties. We estimate fair values based upon quoted market prices or broker dealer quotes and these estimates may vary in the near term. Fair value disclosures with respect to debt securities are detailed in Note 5 to the financial statements. The fair value of other financial instruments, principally cash and cash equivalents, reinsurance balances receivable, accrued investment income, promissory note receivable and other liabilities, approximates their recorded value due to the short term nature of the balances. F-21 Note 13 Commitments, Contingencies, Concentrations and Related-Party Transactions Commitments The Company leases office space under a non-cancelable operating lease, which expires in 2004. The Company's future minimum lease commitments at year end 2001 total $660 and are payable as follows: 2002, $317; 2003, $317; 2004, $26. Total office rent expense for the 2001 year, 2000 year, the 1999 period and the 1999 year was $393, $441, $227 and $328 respectively. Contingencies Concurrent with the Trenwick/LaSalle business combination, Trenwick entered into an amended and restated $490,000 credit agreement with various lending institutions. The agreement consists of both a $260,000 revolving credit facility and a $230,000 letter of credit facility. The revolving credit facility has subsequently been converted into a four-year term loan. The primary obligors are two of Trenwick's subsidiary companies. Guarantees are provided by the Company with respect to these obligations. The letter of credit facility is scheduled to expire in November 2002. The term loan facility is subject to scheduled principal amortization over the four-year period in accordance with the following schedule: 2002, 22.5%; 2003, 27.5%; 2004, 32.5%; 2005, 17.5%. The applicable interest rate on borrowings under the credit facility is generally 2.5% above the London Interbank Offered Rate and was 4.7% at year end 2001. A portion or all of the term loan must be repaid in the event of equity issuances, asset sales or debt issuances by Trenwick or its subsidiaries. At year end 2001, $195,000 of term loans were outstanding, and $230,000 of letters of credit were outstanding under the credit facility. Should the two Trenwick subsidiary companies or Trenwick be unable to meet the loan repayments as they fall due, and such repayments are not refinanced, the Company would become liable for such repayments under the terms of the guarantees. No liability for any such amounts has been reflected in these financial statements. As a result of recent losses incurred by Trenwick Group Ltd.'s operating subsidiaries, their cash distribution capacities have been significantly reduced. Concentrations During the 2001 year, the Company received 53% of its gross written premiums through two brokers of which Aon accounted for 27% and Guy Carpenter accounted for 26%. During the 2000 year, 1999 period and the 1999 year, Aon provided 23%, 4% and 18% and Guy Carpenter provided 19%, 40% and 20% of the Company's gross written premiums. Loss of all or a substantial portion of the business provided by these brokers could have an immediate material adverse effect on the business and operations of the Company. The Company does not believe, however, that the loss of such business would have a long-term adverse effect because of the Company's competitive position within the reinsurance market and the availability of business from other brokers. No one ceding company accounted for more than 3% of the Company's gross written premiums in the 2001 or 2000 years, or the 1999 period or year. At year end 2001, 93% of the Company's net reinsurance recoverables on unpaid claims and claims expenses is recoverable from five principal retrocessionaires. The reinsurance recoverable balances, were from GE Frankona, ($18,000), London Life ($17,500), Western General ($7,500), Irish European Re ($5,000), and IPC Re ($5,000). Each of these companies is rated "A" or better by A.M. Best Company. F-22 Included in reinsurance deposits in the balance sheet at year end 2000 is $27,422 which was deposited with Allianz. Related Party Transactions with Trenwick During the 2001 and 2000 year, the Company purchased $10,650 and $13,000 par value, respectively of Trenwick Capital Trust I Preferred stock for $8,461 and 9,902, respectively, which are included in debt securities. This stock matures in 2037 and provides preferential cumulative semi-annual cash distributions at an annual rate of 8.82% which are guaranteed by Trenwick America Corporation, within certain limits, as to distribution payments and liquidation or redemption payments. Income recognized on this investment was $1,806 and $166 for the 2001 and 2000 years, respectively. The market value of the investment at year end 2001 and 2000 was $13,021 and 9,848, respectively. The amortized cost was $18,380 and $9,905, respectively. Unrealized losses of $5,359 and $57, respectively, are included in accumulated other comprehensive income at year end 2001 and 2000. At year end 2001, $75,000 was receivable from Trenwick with respect to a loan advanced during the 2000 year. Interest is charged on this loan at a rate equal to that generated by the Company's investment portfolio. Interest recognized for the 2001 year was $4,688. Also at year end 2001, $11,651 was receivable from Trenwick with respect to an intercompany account balance. This is repayable on demand and is interest free. Other Related Party Transactions Two of the Company's founding shareholders were CNA Financial and Aon. Their ownership of the Company during the period prior to the Trenwick/LaSalle business combination was between 15.6% and 18.3% for CNA and 15.3% and 18.0% for Aon. The Company had numerous business relationships with both companies, the principal ones of which are summarized below: 1999 Period 2000 Year and Year --------- -------- Premiums assumed through Aon $30,340 $25,448 Brokerage costs on premiums assumed through Aon 3,034 2,544 Investment management services from Aon 821 1,000 Premiums assumed from CNA 668 8,386 Premiums ceded to CNA 6,556 7,909 Override and profit commissions on premiums ceded to CNA 1,244 644 Underwriting support services from CNA 685 1,634 While the 2001 underwriting support services agreement between the Company and CNA did not terminate until September 30, 2001, the Company did not utilize CNA's underwriting support services following the Trenwick/LaSalle business combination. Consequently, all fees payable between September 30, 2000 and September 30, 2001 were accrued and expensed at the date of the Trenwick/LaSalle business combination. The investment management services agreement between LaSalle Re Holdings Limited and Aon terminated at year end 2000. F-23 The Company loaned Mr. Hengesbaugh $142,321 in 2001 to finance a portion of the purchase price of a home in Bermuda. The loan is evidenced by a demand promissory note and interest is payable at the rate of 8% per annum. Note 14 Additional Operating Cash Flow Information Operating activities are presented in the consolidated statement of cash flows on a direct basis. The indirect basis reconciles net income (loss) to cash from (for) operating activities. This reconciliation follows:
2001 2000 1999 1999 Year Year Period Year --------- -------- -------- -------- Net income (loss) $(11,245) $23,265 $(14,841) $(2,834) Investment premium amortization, net 418 (1,212) (692) 154 Net realized investment losses (gains) (7,567) 1,688 -- (615) Unrealized loss (gain) on foreign exchange (803) (405) 193 193 Negative goodwill accretion (488) (122) -- -- Minority interest in undistributed net income (loss) of subsidiaries -- 839 (4,990) (2,845) Restricted stock compensation expense -- 693 91 751 Changes in assets and liabilities, net of effect from purchases of subsidiary: Accrued investment income 2,578 (2,555) (2,139) 981 Premiums receivable (8,101) 652 14,770 (6,354) Reinsurance recoverable balances (50,748) 11,346 (8,676) (9,100) Prepaid reinsurance premiums 2,529 402 6,172 (9,726) Deferred policy acquisition costs 2,683 853 3,441 1,533 Other assets 26,748 8,558 (1,000) (5,916) Trenwick Group Ltd. advances (7,649) (5,598) -- -- Unpaid claims and claims expenses 105,705 (14,472) 43,593 48,403 Unearned premium income (4,992) (9,966) (27,154) (6,070) Reinsurance balances payable 3,331 (376) (2,243) 9,778 Other liabilities (254) (2,223) 2,044 1,609 --------- -------- -------- -------- Cash from (for) operating activities $52,145 $11,367 $8,569 $19,942 ========= ======== ======== ========
F-24 Note 15 Unaudited Quarterly Financial Data Summarized unaudited quarterly financial data for the years presented is as follows:
Quarter 2001 2000 --------------- ------- ------- Net premiums earned Fourth quarter $18,324 $25,357 Third quarter 29,777 26,751 Second quarter 27,813 28,776 First quarter 21,628 27,212 Net investment income Fourth quarter 9,795 9,666 Third quarter 9,900 9,591 Second quarter 9,776 9,251 First quarter 9,457 8,936 Net realized investment Fourth quarter (150) 228 Gains (losses) Third quarter 1,348 270 Second quarter 784 38 First quarter 5,585 (2,224) Net income (loss) Fourth quarter 28,567 15,610 Third quarter (68,696) 8,552 Second quarter 9,691 12,912 First quarter 19,193 (13,809) Net income (loss) Fourth quarter 26,926 13,969 available to common Third quarter (70,337) 6,911 shareholders Second quarter 8,050 11,271 First quarter 17,552 (15,450)
F-25