10-K 1 a2043063z10-k.txt 10-K -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000 COMMISSION FILE NUMBER 000-2348\ ------------------------ ESG RE LIMITED (Exact name of registrant as specified in its charter) BERMUDA NOT APPLICABLE (State or other jurisdiction of Incorporation of (I.R.S. Employer Identification No.) organization)
16 CHURCH STREET HAMILTON HM11, BERMUDA (Address of executive offices, zip code) (441) 295-2185 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: TITLE OF EACH CLASS Common Shares, $1.00 par value NAME OF EACH EXCHANGE ON WHICH REGISTERED Nasdaq National Market 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. The aggregate market value of the voting stock held by non-affiliates of the Registrant, as of March 15, 2001, was $29,469,312 based on the closing price of $2.50 on that date. The number of the Registrant's common shares (par value $1.00 per share) outstanding as of March 15, 2001 was 11,787,725. DOCUMENTS INCORPORATED BY REFERENCE: Certain portions of the Definitive Proxy Statement in connection with the 2001 Annual General Meeting of Shareholders (the "Proxy Statement") which will be filed with the Securities and Exchange Commission not later than 120 days after the Registrant's fiscal year ended December 31, 2000, pursuant to Regulation 14A are incorporated by reference in Part III of this Form 10-K. -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- PART I. Unless the context requires otherwise, references herein to the "Company" or "ESG Re" include ESG Re Limited and the subsidiaries through which it operates. All references to the Company prior to the closing of its initial public offering on December 12, 1997 are to the Company's reinsurance management business, which was conducted through its subsidiary, European Specialty Group Holding AG ("ESG Germany") and its subsidiaries. CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS A number of written statements made by the Company in this document, other documents filed with the Securities and Exchange Commission, press releases, conferences, or otherwise that are not historical facts, or are preceded by, followed by or include the words "believes," "expects," "anticipates," "estimates," or similar expressions, or that relate to future plans, events or performance are forward-looking statements within the meaning of the federal securities laws. When a forward-looking statement includes an underlying assumption, the Company cautions that, while it believes the assumption to be reasonable and makes it in good faith, assumed facts almost always vary from actual results, and the difference between assumed facts and actual results can be material. Where, in any forward-looking statement, the Company expresses an expectation or belief as to future results, there can be no assurance that the expectation or belief will result. The Company's actual results may differ materially from those expressed in any forward-looking statements made by the Company. The following important factors, among others, would cause actual results to differ materially from those set forth in the forward-looking statements: claims frequency, claims severity, economic activity, competitive pricing, legal matters and the regulatory environment in which the Company operates. Other risks are referred to from time to time in the Company's periodic filings with the Securities and Exchange Commission. ALL FORWARD-LOOKING STATEMENTS OF THE COMPANY ARE QUALIFIED BY AND SHOULD BE READ IN CONJUNCTION WITH SUCH RISK DISCLOSURE. EXCEPT AS MAY BE REQUIRED BY APPLICABLE LAW, THE COMPANY UNDERTAKES NO OBLIGATION TO PUBLICLY UPDATE OR REVISE ANY FORWARD-LOOKING STATEMENTS, WHETHER AS A RESULT OF NEW INFORMATION, FUTURE EVENTS OR OTHERWISE. ITEM 1. BUSINESS GENERAL DEVELOPMENT OF THE BUSINESS ESG Re Limited was formed on August 21, 1997, as an exempted company limited by shares under the laws of Bermuda. The Company is a specialty reinsurance company providing accident, health, life, disability and related special risk reinsurance to the insurance industry on a worldwide basis. With operating risk carriers located in Ireland, Bermuda and Germany and offices in 10 countries, ESG Re underwrites risks in more than 50 nations. The Company, through Accent Europe Insurance Company Ltd. ("Accent") offers its products on a pan-European basis directly to its insured parties. In the former Soviet State of Georgia, ESG Re helped to establish one of the first locally-managed insurance companies to be run along Western business standards, supplying a range of products and services. The Company through its support center provides centralized global support for underwriting, claims, systems and technology, finance and accounting, legal, human resources and policy administration. DISCONTINUED OPERATIONS In December 1998, the Company initiated the creation of a non profit healthcare association, COMED, in the German market. Member services include physician referrals, a medical information hotline, second opinion services and access to disease management advisors. Such services are commonly referred to as demand management services in Germany. 2 In March 2000, the Company completed the acquisition of Innovocare GmbH, a disease management company based in Munich, Germany. The above entities formed the core of the Company's Health Care division with an aim at developing and distributing disease management programs and cardiovascular programs. On August 10, 2000, the Board of Directors approved a plan for the divestiture of the Health Care division. Implementation of that plan resulted in the divestiture of 4Sigma (formerly VBB Bermuda Limited) effective June 30, 2000 to affiliates of the Chief Executive Officer ("CEO") and senior management of the Health Care division. The investors in 4Sigma include the Company, affiliates of the Chief Executive Officer of the Company, Dr. Gerald Moeller, previously a member of the board of ESG Re Limited and chief executive of the Health Care division and former management of the Health Care division. Terms comparable to those offered to affiliates of the CEO were offered to non-related parties. The Company owns 8,000,000 convertible preference shares in 4Sigma, par value $1 per share. The book value of $8.0 million for the Company's equity position is included in other investments. The operations of 4Sigma have entered into a strategic partnership with Bertelsmann/Springer for the marketing of its services to German health insurers. Currently, sales proposals have been made to three of the largest insurers with decisions due in April and May 2001. The expectation is that the group will be successful on at least one of the proposals. In the event none of the proposals are accepted, then the group would be in a position to revisit its business model and ESG Re would re-value its investment in 4Sigma. Reference is made to Note 11 of Notes to Financial Statements concerning the divestiture of this operation. MARKET GROWTH The Company believes that it is well positioned to benefit from natural market growth in its Direct Marketed Accident/Health Products and Bancassurance lines of business. In addition, although the traditional reinsurance business has been greatly reduced, the areas where ESG Re continues to write this type of reinsurance still offer growth opportunities because of its expertise, experience and existing relationships. BUSINESS STRATEGY The business plan for ESG Re is that of a specialty niche reinsurer focused in two areas: - Traditional Reinsurance - Partnership Enterprises TRADITIONAL REINSURANCE Capital for 2001 has been allocated to those markets in which ESG Re can achieve its desired profit margins. - Significant capital has been assigned to the North America Reinsurance market in order to take advantage of current opportunities in the hardening United States medical market. However, in order to reduce earnings volatility, ESG Re will co-reinsure up to 75% of the medical portfolio. In addition, this region is pursuing opportunities in partnership with a number of leading insurers to develop and market a critical illness product in the United States. - Capital allocation has been reduced by up to 50% in those regions where the desired margins on the current premium volumes can not be achieved. - Continental Europe has been scaled down significantly. 3 In addition to this disciplined allocation of capital and in order to manage compliance with these premium targets, all underwriting has been centralized in the Company's shared services center in Dublin. PARTNERSHIP ENTERPRISES ESG Re will continue to complement traditional reinsurance business with an approach that is based on establishing solid relationships with partners through the provision of value added services to those partners. In Asia Pacific through direct response marketing, ESG Re provides telemarketing expertise from a team of experienced professionals. The Company will continue to invest in and expand on this operation. In addition, the Company has recently initiated a direct response marketing operation in Europe. In the second half of 2000, the Company began another Partnership Enterprise in Europe with a team of experienced professionals. This is a Bancassurance operation in Portugal which provides niche wholesale services in the credit business. It will focus on providing value added services to banks, finance houses and credit unions in the marketing of credit, life and related products. This team will develop business throughout Europe after the initial set up in Portugal. PRODUCTS AND SERVICES ESG Re intends to develop reinsurance products and services that are tailored to the needs of particular markets and distribution channels. These products are life, accident and health. The Company offers assistance to ceding companies and other partners in the areas of underwriting, actuarial systems, product design and marketing. BUSINESS SEGMENTS Prior to June 30, 2000, the Company's operations comprised two business segments, Reinsurance and Health care. Effective June 30, 2000, the Company divested its Health Care division, which was established in 1999. The results from the Health Care division are now being reported as Discontinued Operations; prior periods have been restated as such. Effective with the divestiture of the health care business, the Company now considers its reinsurance activities to constitute a single operating segment on the basis that such activities are monitored and evaluated primarily on a company-wide basis. The major lines of business of the Company's reinsurance operations include medical expense, personal accident and disability, credit, life and other special risk reinsurance. ESG Re's gross premiums written in 2000 totaled $245.0 million (1999: $333.0 million, 1998: $199.9 million). The breakdown of gross premiums written for the years ended December 31, 2000, 1999 and 1998 by major lines of business was as follows:
2000 1999 1998 -------- -------- -------- Medical Expense....................................... 71.0% 75.7% 59.6% Personal Accident and Disability...................... 22.0% 19.9% 26.1% Credit................................................ 1.4% 0.6% 6.2% Life.................................................. 3.7% 2.1% 5.5% Other................................................. 1.9% 1.7% 2.6% ----- ----- ----- Total................................................. 100.0% 100.0% 100.0% ===== ===== =====
4 Further information is disclosed in Item 7, "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS." MEDICAL EXPENSE Medical expense reinsurance consists primarily of medical expense reimbursement plans, specific and aggregate, short-term travel, defined illnesses and dread diseases, as well as medical expense add-on coverages and top-up benefits. To properly evaluate these reinsurance risks, ESG Re relies on its detailed knowledge of the underlying insurance product and active risk management. ESG Re encourages its ceding clients through regular client meetings and audits to employ stringent cost control and loss prevention measures, such as managing a patient's choice of doctors and hospital networks, reducing benefit utilization and reducing claims frequency. The restructuring of social security systems throughout numerous countries generates the need for private insurance and, consequently, generates reinsurance demand. New markets have emerged worldwide, due to changes in laws that have transferred insurance responsibility from government funds to private institutions. PERSONAL ACCIDENT Personal accident reinsurance covers death and dismemberment, disability, loss of license and special coverages for credit card issuing corporations relating to injuries to card holders. The reinsurance of non-traditional risks, such as tailor-made coverage for occupational injuries, also comprises an important part of ESG Re's personal accident reinsurance business. The Company favors the "local approach" to personal accident reinsurance (i.e. it acquires direct knowledge of the underlying business by establishing personal relationships and transacting business directly with the ceding clients or local brokers in the country of origin). CREDIT/LIFE ESG Re provides credit reinsurance for defaults resulting from the perils of death, accident, disability and unemployment. ESG Re has considerable experience underwriting credit/life reinsurance in various markets. During 2001, ESG Re is planning to become licensed as a reinsurer of credit risks in Portugal. UNDERWRITING The Company employs a disciplined and centralized approach to underwriting in order to maximize underwriting profitability. The Company has reassessed the structure of its overall portfolio and decided to concentrate resources in those areas and on those products which indicate the greatest potential for profit. With an emphasis on underwriting profitability, the Company has cancelled contracts with ceding companies when underwriting profits were not in line with expectations. Underwriting new and renewal business is conducted on a risk-by-risk basis, with consideration given to the general direction of rates, policy terms, loss histories and future exposures, ESG Re's acceptance limits and general book of business. As part of its underwriting process, the Company focuses on the reputation of the proposed ceding company, the likelihood of establishing a long-term relationship, the geographic area in which the ceding company conducts business and the ceding company's market share. The Company reviews historical loss data in order to compare the ceding company's historical loss experience to industry averages, as well as the perceived financial strength of the ceding company. Over time, the Company has developed its own manuals that serve as a detailed underwriting guideline. 5 The Company protects its portfolio by effecting non-proportional reinsurance coverage in various layers to protect against large individual and aggregate losses and risks of known and unknown concentration. In addition, the Company will continue to effect proportional coverage on underwritten risks that might have fluctuating results. The Company, together with co-reinsurers, provides the following gross capacities: Medical Expense.............................. $5 million lifetime benefit per person Personal Accident and Disability............. $3 million any one person and $30 million in accumulated losses from any one known event Credit/Life.................................. $1 million any one person Special Risk................................. $3 million any one event or series of events
The Company does not intend to expose itself to risk in excess of $250,000 per person on Medical business and $1,000,000 per person and per event for all other lines of life, accident and health business. CLAIMS Normally, a reinsurer is not actively involved in claims handling at first dollar level. It is the task of the ceding client to adjust the original claim made by its direct insureds. To the extent possible, the Company's approach differs from other reinsurers in that it actively seeks to reduce claim costs in most of its medical expense reinsurance lines while its reinsurance policies are in effect. The Company's claims handling assistance, particularly for complicated cases, has proven in many instances to be successful in significantly reducing loss ratios of ceding clients' portfolios in comparison to their loss ratios before ESG Re's involvement. Involvement in claims handling also will allow the Company to be constantly aware of claims development in the health care field and to establish reserves more accurately at an early point in time. These claims support techniques have also proven to be an important tool in the acquisition of new business. Depending on the experience and the retention of the ceding client and the extent of non-proportional reinsurance made available, the Company will require either claims control or claims co-operation clauses in the reinsurance treaties it negotiates. Claims control clauses allow the reinsurer to determine the extent to which a claim will be paid, whereas claims co-operation clauses require the agreement of the insurer and reinsurer to jointly determine the extent to which a claim will be paid. These clauses may improve the claims performance of a ceding client, which might not be sufficiently experienced in dealing with complex issues. The Company performs audits at its ceding clients where deemed necessary. Such audits may include underwriting, claims, financial, and systems audits. Qualitatively, such audits test compliance and discover weaknesses in the reporting and reserving system of a ceding client and thereby help the ceding client to arrive at a realistic and timely methodology to evaluate risk exposure. OPERATIONS The Company has structured its reinsurance underwriting operations according to business lines. Specific underwriters in Ireland are responsible for underwriting the business according to internal guidelines and procedural and underwriting manuals, as well as for supervising claims and handling claims subsequent to entering into the contracts. Business is monitored monthly by the underwriting and actuarial departments. The Company through its shared services support center, provides centralized global operational support for underwriting, claims, systems and technology, finance and accounting, legal, human resources and insurance administration. 6 RESERVES The Company expects that, due to the short-tail nature of most classes of business, most claims under its treaties will generally become known and ascertainable within approximately 12 to 36 months from the date the insurance policy is written. The majority of the Company's reinsurance contracts permit annual adjustment of terms. The reserve for unpaid losses and loss adjustment expenses includes an estimate of reported case reserves and an estimate for losses incurred but not reported. Case reserves are estimated based on ceding company reports and other data considered relevant to the estimation process. The liability for losses incurred but not reported is based to an extent on the expectations of ceding companies about ultimate loss ratios at the inception of the contracts, supplemented by industry experience and the Company's specific historical experience where available. As the Company has limited specific historical experience on a significant number of its programs on which to base its estimate of losses incurred but not reported, its reliance on ceding company expectations and industry experience is necessarily increased, which increases the uncertainty involved in the loss estimation process. The reserves as established by management are reviewed periodically, and adjustments are made in the periods in which they become known. Although management believes that an adequate provision has been made for the liability for losses and loss expenses based on all available information, there can be no assurance that the ultimate losses will not differ significantly from the amounts provided. INVESTMENTS As of December 31, 2000, the Company's cash and invested assets totaled $212.2 million. The Company has developed specific investment guidelines for the management of its investment portfolio. Although these guidelines stress diversification of risk, preservation of capital and market liquidity, investments are subject to market risks and fluctuations, as well as to risks inherent in particular securities. The Company's primary investment objective for the portfolio is to preserve the capital assets of the Company while achieving a total return commensurate with market conditions. At December 31, 2000, ESG Re had invested $10.7 million primarily into reinsurance related enterprises with a further $2 million invested in its majority owned Georgian subsidiary, IMEDI L. Insurance Company Limited ("IMEDI"). In addition, the Company has outstanding loans of $7.0 million with two of these related enterprises as at December 31, 2000. In 1997, the Company entered into an Investment Advisory Agreement with Head Asset Management L.L.C. to supervise and direct the investment of the Company's asset portfolio in accordance with, and subject to, the investment objectives and guidelines established by the Company. The agreement was revised on July 1, 2000. Pursuant to the terms of the Investment Advisory Agreement, the Company will pay a fee, payable quarterly in arrears, equal to 0.20% per annum of the first $150 million or less of the market value of the assets under its management declining to 0.15% per annum of the assets under its management, in excess of $150 million. The Investment Advisory Agreement may be terminated upon 90 days written notice by the investment advisor or by the Company on five days notice or upon shorter notice if mutually agreed in writing by both parties. See "Certain Relationships and Related Transactions." The performance of, and the fees paid to, the Investment Advisor has been and will continue to be reviewed periodically by the Board of Directors. MATURITY AND DURATION OF PORTFOLIO The maximum effective maturity for any single security in the Company's investment portfolio is set at 30 years for U.S. government and U.S. government agency securities with full faith and credit guarantees and at 10 years for all other issues, measured from the date of settlement. The duration of the portfolio varies according to decisions taken by the investment advisor on the outlook for interest rate movements. The benchmark for such duration is approximately 3 years. 7 QUALITY OF DEBT SECURITIES IN PORTFOLIO The minimum average credit quality of the Company's investment portfolio is AA. EQUITY SECURITIES AND REAL ESTATE The Company's investment policy is to allow up to 10% of its investment assets to be held in equity securities. Private equity investments ("strategic investments") have been placed with strategic partners in order to support ESG Re's core business or to secure distribution. The Company does not intend to invest in real estate other than for its own use. DIVERSIFICATION AND LIQUIDITY No more than 3% of the Company's investment portfolio may be invested in the securities of any single issuer, with the exception of sovereign governments or agencies, including supranational agencies, with an AA rating or better. FOREIGN CURRENCY EXPOSURES The Company's investment portfolio is invested predominantly in fixed income securities denominated in U.S. dollars, Euros and German Marks. The Company's primary risk exposures and premiums receivable are denominated predominantly in U.S. dollars and European currencies. The Company intends to hold investments in the currencies in which it will collect premiums, pay claims and hold reserves thus creating a partial natural foreign exchange hedge against exchange rate fluctuations. COMPETITION ESG Re has a small number of competitors worldwide mainly Swiss Re, Munich Re, American International Group and CIGNA. Other competition tends to be local to the country in which the Company operates. In traditional reinsurance competition comes from international reinsurers, local market reinsurers and various forms of intermediaries. In direct marketing and bancassurance, competition comes from a small number of international reinsurers and financial services companies. ESG Re benefits in all segments from the specialized skills and experiences of its employees. EMPLOYEES As of March 15, 2001, the Company had 135 full time employees. None of these employees is represented by a labor union. The Company expects to add additional underwriting, marketing and administrative staff consistent with the implementation of the Company's business plan. The Company believes that its employee relations are generally good. REGULATION BERMUDA THE COMPANIES ACT 1981 (AS AMENDED) AND RELATED REGULATIONS. The Companies Act regulates the business of both the Company and ES Bermuda. THE INSURANCE ACT 1978 (AS AMENDED) AND RELATED REGULATIONS. The Insurance Act 1978 of Bermuda (as amended) and related regulations from time to time in force (the "Act"), which regulates the business of ES Bermuda, provides that no person shall carry on an insurance business in or from within Bermuda unless registered as an insurer under the Act by the Minister of Finance. The Minister of Finance, in deciding whether to grant registration, has broad discretion to act as he thinks fit in the 8 public interest. The Minister of Finance is required by the Act to determine whether the applicant is a fit and proper body to be engaged in insurance business and, in particular, whether it has, or has available to it, adequate knowledge and expertise. In connection with registration, the Minister of Finance may impose conditions relating to the writing of certain types of insurance. An Insurance Advisory Committee and sub-committees thereof appointed by the Minister of Finance advises him on matters connected with the discharge of his functions and supervises and reviews the law and practice of insurance in Bermuda, including reviews of accounting and administrative procedures. The Act imposes solvency and liquidity standards and auditing and reporting requirements on Bermuda insurance companies and grants to the Minister of Finance powers to supervise, investigate and intervene in the affairs of insurance companies. Significant aspects of the Bermuda insurance regulatory framework are set out below. CANCELLATION OF INSURER'S REGISTRATION. An insurer's registration may be cancelled by the Minister of Finance on certain grounds specified in the Act, including failure of the insurer to comply with its obligations under the Act or if, in the opinion of the Minister of Finance, after consultation with the Insurance Advisory Committee, 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, which are required to be filed annually with the Registrar of Companies (the "Registrar"), who is the chief administrative officer under the Act. The auditor must be approved by the Minister of Finance as the independent auditor of the insurer. The approved auditor may be the same person or firm which audits the insurer's financial statements and reports for presentation to its shareholders. STATUTORY FINANCIAL STATEMENTS. An insurer must prepare annual statutory financial statements. The 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). 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 U.S. GAAP and are distinct from the financial statements prepared for presentation to the insurer's shareholders under The Companies Act 1981 of Bermuda, which financial statements may be prepared in accordance with U.S. GAAP. Copies of the Company's and ES Bermuda's statutory financial statements must be filed annually together with its statutory financial return. The statutory financial statements must be maintained at the principal office of the insurer for a period of five years. MINIMUM CAPITAL AND SURPLUS. Under the Act, ES Bermuda has been designated as a Class 3 composite insurer. The Act requires $1.25 million minimum capital and surplus for Class 3 composite insurers (i.e. insurers which write both general business and long-term business) with a minimum paid up share capital of $370,000. MINIMUM SOLVENCY MARGIN. The Act provides that the statutory assets of a Class 3 insurer writing general business must exceed its statutory liabilities by an amount equal to or greater than the applicable minimum solvency margin for that class. The applicable minimum solvency margin for a Class 3 insurer is 20% of net premiums written for the first $6 million of net premiums written plus 15% of net premiums written in excess of $6 million or 15% of loss and loss expense reserves, whichever is greater. The minimum solvency margin for writers of long-term business is $250,000. MINIMUM LIQUIDITY RATIO. The Act provides a minimum liquidity ratio for insurers which write 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 9 cash and time deposits, quoted investments, unquoted bonds and debentures, first liens on real estate, investment income due and accrued, accounts and premiums receivable, reinsurance balances receivable and funds held by ceding reinsurers. There are certain categories of assets which, unless specifically permitted by the Minister of Finance, 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) and certain letters of credit and guarantees. STATUTORY FINANCIAL RETURN. A Class 3 insurer is required to file with the Registrar an Annual Statutory Financial Return at the same time as it files its statutory financial statements but, in any event, no later than four months from the insurer's 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 schedule of ceded reinsurers, an annual actuarial opinion on loss reserves prepared by the approved loss reserve specialist and a declaration of the statutory ratios and a solvency certificate. SUPERVISION, INVESTIGATION AND INTERVENTION. The Minister of Finance may appoint an inspector with extensive powers to investigate the affairs of an insurer if the Minister of Finance 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 of Finance may direct an insurer to produce documents or information relating to matters connected with the insurer's business. If it appears to the Minister of Finance that there is a risk of the insurer becoming insolvent, the Minister of Finance 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 Bermuda, or transfer to the custody of a Bermuda bank, certain assets; and to limit its premium income. An insurer is required to maintain a principal office in Bermuda and to appoint and maintain a principal representative in Bermuda to oversee the business of the Company and to report to the Minister of Finance and the Registrar of Companies in respect of certain events. Unless the approval of the Minister of Finance has been obtained, 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 of Finance 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 an "event" has occurred, to make a written report to the Minister of Finance setting out all the particulars of the case that are available to him. Examples of such an "event" include failure by the insurer to comply substantially with a condition imposed upon the insurer by the Minister of Finance relating to a solvency margin or a liquidity or other ratio. DIVIDENDS. The Bermuda Companies Act 1981 would allow dividend payments when there are reasonable grounds for believing that (i) ESG Re will be able to pay its debts as they fall due after payment of a dividend, and (ii) ESG Re's assets will exceed the aggregate value of its liabilities and its issued share capital and premium accounts. The Bermuda Insurance Act 1978 requires ES Bermuda to maintain a minimum solvency margin and a minimum liquidity ratio. REDUCTION OF STATUTORY CAPITAL. Approval is needed from the Minister of Finance for any reduction in total statutory capital of an insurance company of 15% or more. Applicants are required to show that the proposed reduction of capital will not cause ES Bermuda to fail to meet applicable statutory margin requirements in Bermuda. 10 GERMANY The German regulatory framework for the insurance industry is provided by the Insurance Supervisory Law (Versicherungsaufsichtsgesetz, or "VAG"). The supervision of all insurance companies domiciled in Germany is the responsibility of the BAV, which is an agency of the Ministry of Finance. Other than the area of primary insurance, reinsurance has been largely liberalized. Consequently, except as set forth below, there are no detailed regulations for reinsurers under the law of the European Union or Germany. A professional reinsurance company requires no license from the BAV. Only a summary filing is required, setting forth the domicile and corporate form of the reinsurance company and the members of the executive and supervisory boards. The BAV encourages reinsurers to submit the names of the company's shareholders with such filings, and also to include the qualifications of the members of the executive and supervisory boards. The submission of a business plan is not necessary. Insurance and reinsurance companies are under the direct supervision of the BAV. For reinsurers, however, the level of supervision is substantially relaxed, and pertains primarily to the financial supervision of reinsurers, requiring only submission of financial statements. Except as set forth above, the provisions of the VAG and the Capitalization Law (Kapitalausstattungs VO) do not apply to reinsurers. Reinsurance mutuals (Ruckversicherungsverein VVaG) are subject to solvency controls. Reinsurance companies, such as ES Germany, are not subject to capitalization requirements, but the BAV prefers that reinsurance companies have the same level of capitalization as primary insurers (approximately 16 - 18% of net premiums). Sections 55 - 59 VAG, pertaining to accounting and auditing of insurance companies, are also applicable to reinsurance companies. IRELAND Irish law directly regulates only two of the Company's subsidiaries, ES Ireland and Accent. REGULATION. Direct insurance business in Ireland is regulated by an extensive list of acts and regulations from the Assurance Companies Act 1909 to the Insurance Act 1989 and the European Communities (Non Life Insurance) Regulations 1976 to the European Communities (Non Life Insurance) Framework Regulations 1994. Direct insurance companies must be authorized by the Minister for Enterprise, Trade and Employment (the "Minister") before commencing business. Specialist reinsurers incorporated in Ireland, such as ES Ireland, are not subject to authorization by the Irish Government and are only required, pursuant to section 22 of the Insurance Act 1989, to notify the Minister that they carry on the business of reinsurance and to provide information to the Minister regarding ownership, share capital, directors, senior management, accountants, auditors and solicitors as well as risks to be covered and related policy and other arrangements. AUDITOR'S REPORT AND DUTIES. The Companies Act 1963 requires all companies incorporated in Ireland to prepare and have audited annual accounts for their shareholders. Section 22(1) Insurance Act 1989 requires reinsurance companies to prepare their accounts in such form as the Minister may specify and such audited accounts are required to be filed in the Companies Registration Office and are available for public inspection. GEORGIA Georgia law directly regulates only one of the Company's subsidiaries, IMEDI. REGULATION. The Georgian Parliament adopted an Insurance Regulation in 1996 regarding foreign ownership and capitalization requirements. Specific laws governing automobile third party liability 11 insurance and compulsory fire insurance were introduced in 1997 and 1999 respectively. Regulation is carried out by the Insurance State Supervision Service. MINIMUM CAPITAL REQUIREMENTS: The minimum capital requirement for an insurance company to underwrite most lines of insurance is GEL500 thousand. For a company carrying out life insurance, the requirement is increased to GEL600 thousand and to GEL1 million for a company carrying out pension insurance. UNITED STATES AND OTHER The Company is not admitted to do insurance or reinsurance business in any jurisdiction except Bermuda, Ireland, Germany, and Georgia. The Company has applied for authorization to do reinsurance business in Hong Kong. The insurance laws of each state of the United States and of many foreign countries regulate the sale of insurance within their jurisdictions by alien insurers, such as the Company, which are not admitted to do business within such jurisdictions. With some exceptions, such sale of insurance within a jurisdiction where the insurer is not admitted to do business is prohibited. The Company does not intend to maintain an office or to solicit, advertise, settle claims or conduct other insurance activities in any jurisdiction where the conduct of such activities would require that the Company be so admitted and the Company is not so admitted. ITEM 2. PROPERTIES ESG Re and its subsidiaries lease office space in Bermuda, Dublin, Hamburg, London, Lisbon, Toronto, Miami, Hong Kong, Singapore, Taiwan, Sydney and Bangkok and own an office located in the former Soviet State of Georgia. The owned property is currently valued at $290,000. The Company believes its space is adequate to meet its current and expected needs. ITEM 3. LEGAL PROCEEDINGS ESG Re and its subsidiaries, in common with the insurance industry in general, are subject to litigation, including claims for punitive damages, in the normal course of their business. ESG Re does not believe that such litigation will have a material adverse effect on its financial condition, future operating results or liquidity. (See also Management's Discussion and Analysis of Financial Condition and Results of Operations and Note 11 of Notes to Financial Statements.) 12 PART II. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the fourth quarter of fiscal 2000. ITEM 5. MARKET FOR COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS MARKET INFORMATION Since December 12, 1997, the common stock of the Company has been traded on NASDAQ under the symbol ESREF. The highest and lowest sales prices of the Company's common stock for each fiscal quarter since December 31, 1998 were as follows:
HIGH LOW -------- -------- From January 1 to March 31, 1999............................ $22.25 $15.63 From April 1 to June 30, 1999............................... $20.06 $14.00 From July 1 to September 30, 1999........................... $16.75 $ 8.63 From October 1 to December 31, 1999......................... $ 9.38 $ 5.13 From January 1 to March 31, 2000............................ $ 6.52 $ 2.97 From April 1 to June 30, 2000............................... $ 4.53 $ 3.46 From July 1 to September 30, 2000........................... $ 4.01 $ 2.43 From October 1 to December 31, 2000......................... $ 4.00 $ 1.72
NUMBER OF RECORD HOLDERS OF COMMON STOCK The number of record holders of the common stock of the Company as of March 15, 2001 was 144. DIVIDEND HISTORY AND RESTRICTIONS The dividend history of the Company for each fiscal quarter since December 31, 1998 is as follows:
DIVIDEND DATE DATE RECORD OF DECLARED DECLARED SHAREHOLDERS DATE PAID -------- ---------------- ------------------ ------------------ February 25, $0.08 1999 March 15, 1999 March 22, 1999 $0.08 May 7, 1999 May 24, 1999 June 4, 1999 $0.08 August 10, 1999 August 23, 1999 September 8, 1999 $0.08 November 8, 1999 November 22, 1999 December 8, 1999 February 25, $0.08 2000 March 15, 2000 March 30, 2000 $0.08 May 9, 2000 June 15, 2000 June 29, 2000 $0.08 August 10, 2000 September 15, 2000 September 28, 2000
The Company's dividend policy is reviewed quarterly by the Board of Directors. ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA The following table sets forth the selected consolidated financial data for ESG Re Limited and subsidiaries. The financial statements included herein represent the financial performance and results of the Company as an insurer and a reinsurer for the years ended December 31, 2000, 1999 and 1998, as a reinsurer and reinsurance management company for the year ended December 31, 1997 and as a reinsurance management company only for 1996. 13
YEARS ENDED DECEMBER 31 ------------------------------------------------------- 2000 1999 1998 1997 1996 -------- -------- -------- -------- -------- U.S. DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA CONSOLIDATED OPERATING DATA Gross managed premium...................... $254,996 $347,900 $224,204 $100,000 -- Net premiums written....................... 211,886 313,210 195,578 25,392 -- Net premiums earned........................ 236,620 249,125 98,841 13,411 -- Investment income.......................... 12,924 13,515 12,930 598 186 Total revenues............................. 249,032 262,589 115,827 17,839 4,055 Losses and loss expenses................... 187,241 199,031 61,364 7,449 -- Acquisition costs.......................... 78,566 66,296 26,714 4,693 -- Class B Warrants expense................... -- -- -- 3,626 -- Administrative Expenses.................... 22,843 26,490 11,965 7,736 4,062 Total expenses............................. 305,651 290,996 100,043 23,504 4,062 Net underwriting (loss)/income............. (66,306) (39,045) 1,961 1,269 -- Loss expense ratio....................... 79.1% 79.9% 62.1% 55.5% -- Acquisition expense ratio................ 33.2% 26.6% 27.0% 35.0% -- Loss and acquisition expense ratio....... 112.3% 106.5% 89.1% 90.5% -- Net (loss) income from continuing operations............................... (56,618) (29,222) 14,522 (5,096) (163) Net loss from discontinued operations...... (5,178) (12,772) -- -- -- Net income (loss).......................... (61,796) (41,994) 14,522 (5,096) (163) Basic net (loss) income per share from continuing operations.................... (4.79) (2.20) 1.04 (4.11) (1.38) Diluted net (loss) income per share from continuing operations.................... (4.79) (2.20) 1.03 (4.11) (1.38) Basic net (loss) income per share.......... (5.23) (3.17) 1.04 (4.11) (1.38) Diluted net (loss) income per share........ (5.23) (3.17) 1.03 (4.11) (1.38) Dividends declared per share............... $ 0.24 $ 0.32 $ 0.30 $ -- $ -- CONSOLIDATED BALANCE SHEET DATA Investments and cash....................... $212,246 $221,549 $235,246 $236,976 $ 15 Reinsurance balances receivable............ 241,587 276,112 168,274 25,785 -- Total assets............................... 554,794 605,684 466,373 283,553 7,446 Unpaid losses and loss expenses............ 179,614 136,935 44,379 7,846 -- Unearned premiums.......................... 148,124 181,127 111,884 12,168 -- Total shareholders' equity................. 113,566 176,815 244,841 234,375 (489) Book value per share....................... 9.64 15.24 17.58 16.83 -- COMMON STOCK PRICE RANGE High....................................... $ 6.52 $ 22.25 $ 28.75 $ 23.88(1) $ -- Low........................................ $ 1.72 $ 5.13 $ 12.75 $ 21.50(1) $ --
------------------------ (1) 1997 stock prices are for the period from December 12, 1997, the date of the initial public offering, to December 31, 1997. The initial public offering price was $20.00 per share. 14 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THE FOLLOWING IS A DISCUSSION AND ANALYSIS OF THE FINANCIAL CONDITION, RESULTS OF OPERATIONS, LIQUIDITY AND CAPITAL RESOURCES OF ESG RE LIMITED AND ITS SUBSIDIARIES ("THE COMPANY" OR "ESG RE"). THIS DISCUSSION AND ANALYSIS SHOULD BE READ IN CONJUNCTION WITH THE COMPANY'S CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES. RESULTS OF OPERATIONS The Company previously operated two business segments, Reinsurance and Health Care. The Reinsurance division is a specialty reinsurance enterprise providing accident, medical, credit, life and other special risk reinsurance to insurers and selected reinsurers on a worldwide basis, and underwriting management services to co-reinsurers. Effective June 30, 2000, the Company discontinued the operations of its Health Care Division. Reference is made to Note 11 of Notes to Financial Statements for a description of the sale transaction and summary operating results. The Company reported a net loss of $61.8 million for the year 2000, compared to a net loss of $42.0 million for 1999. Included in the results were net losses of $5.2 million and $12.8 million for the years ended December 31, 2000 and 1999 respectively, from discontinued operations. The net loss from continuing operations was $56.6 million for 2000 and $29.2 million for 1999. The results for continuing operations have been disappointing. The nature of ESG Re's business has meant that the Company had continued exposure to underwriting decisions made in previous years. Initially, as the Company had relatively limited specific historical experience on a significant number of its programs on which to base its estimate of losses incurred but not reported, its reliance on ceding company expectations and industry experience was necessarily increased, which increased the uncertainty involved in the loss estimation process. In the second half of the year, the Company reviewed all major contracts with internal and external resources for adequacy of reserving and the related profitability. This resulted in a further strengthening of loss reserves. In response to the results, the Company centralized underwriting in Dublin. In addition, the Company writes at a conservative ratio of 2:1 net written premium to capital. Effective June 30, 2000, the Company divested its Health Care Division. Net losses of $5.2 million in 2000 and $12.8 million in 1999, representing primarily the costs incurred to establish the division and to position the related health care products, are being reported as discontinued operations. As part of the divestment, the Company retained 8,000,000 convertible preference shares, par value $1 per share, in this operation. The book value of $8.0 million for the Company's equity position is included in other investments. The operations of the former Health Care division have entered into a strategic partnership with Bertelsmann/Springer for the marketing of its services to German health insurers. To date, sales proposals have been made to three of the largest insurers with decisions due back in April and May 2001. The expectation is that the group will be successful on at least one of the proposals. In the event none of the proposals are accepted, then the group would be in a position to revisit its business model and ESG Re would revalue its investment. Since the third quarter of 2000, the Company has made significant progress in executing its business plan centered on select reinsurance writings and partnership enterprises. Reserves established appear to be adequate in the Company's efforts to ring fence the issues associated with the 1998 and 1999 underwriting years. While there can be no assurance that the reserves at any given date are adequate to meet the Company's obligations, the amounts reported in the Company's balance sheet are management's best estimate of that amount. The Company is continuing to take action to close out its liabilities on those underwriting years. 15 YEAR ENDED DECEMBER 31, 2000 COMPARED WITH YEAR ENDED DECEMBER 31, 1999 NET UNDERWRITING INCOME For the year ended December 31, 2000, the Company managed, on behalf of itself and its co-reinsurers, total premiums of $255.0 million, of which it placed $10.0 million with co-reinsurers and retroceded $33.1 million, resulting in $211.9 million net premiums written. For the year ended December 31, 1999, the Company managed, on behalf of itself and its co-reinsurers, total premiums of $347.9 million, of which it placed $14.9 million with co-reinsurers and retroceded $19.8 million, resulting in $313.2 million net premiums written. The amount placed with co-reinsurers declined to 3.9% of total premiums managed in 2000 compared to 4.3% in 1999. Gross and net premiums written and net premiums earned for the 12 months ended December 31, 2000 and 1999 were as follows:
YEARS ENDED DECEMBER 31, ------------------- 2000 1999 -------- -------- U.S. DOLLARS IN MILLIONS Total premiums managed...................................... $255.0 $347.9 Amount placed with co-reinsurers............................ (10.0) (14.9) ------ ------ Gross premiums written...................................... 245.0 333.0 Retroceded.................................................. (33.1) (19.8) ------ ------ Net premiums written........................................ $211.9 $313.2 ====== ====== Net premiums earned......................................... $236.6 $249.1 ====== ======
Total premiums managed for the 12 months ended December 31, 2000 consisted of the following: - New Business--approximately $130.5 million, or 51.1%, of total premiums managed was generated from new business. - Renewal Business--approximately $124.5 million, or 48.9%, of total premiums managed was generated from renewal business. During 2000, the Company had reductions in total premiums managed on the 1999 and 1998 underwriting years of $37.1 million, equivalent to 6.6% of gross premium written in these years. This represents differences between estimates made at the time contracts were written and actual amounts reported by ceding companies. Such changes are recorded in the period in which the actual amounts are determined. Underwriting results for the 12 months ended December 31, 2000 and 1999, by line of business and in total, were as follows:
YEAR ENDED DECEMBER 31, 2000 ----------------------------------------------------------------- MEDICAL ACCIDENT CREDIT LIFE OTHER TOTAL --------- -------- -------- -------- -------- --------- U.S. DOLLARS IN THOUSANDS Gross premiums written............. $ 173,919 $ 54,140 $ 3,405 $ 8,977 $ 4,535 $ 244,976 Net premiums written............... 148,285 49,029 3,162 7,845 3,565 211,886 Net premiums earned................ 161,772 57,620 6,588 6,127 4,514 236,620 Losses and loss expenses........... (124,119) (52,406) (2,344) (5,291) (3,081) (187,241) Acquisition costs.................. (53,471) (17,840) (3,527) (1,622) (2,106) (78,566) Operating costs.................... (24,628) (9,677) (844) (1,044) (927) (37,120) --------- -------- ------- ------- ------- --------- Net underwriting income (loss)..... $ (40,446) $(22,303) $ (127) $(1,830) $(1,600) $ (66,306) ========= ======== ======= ======= ======= =========
16
YEAR ENDED DECEMBER 31, 1999 ----------------------------------------------------------------- MEDICAL ACCIDENT CREDIT LIFE OTHER TOTAL --------- -------- -------- -------- -------- --------- U.S. DOLLARS IN THOUSANDS Gross premiums written............ $ 251,984 $ 66,514 $ 1,851 $ 6,934 $ 5,717 $ 333,000 Net premiums written.............. 240,314 61,549 714 5,550 5,083 313,210 Net premiums earned............... 188,016 42,443 3,933 9,593 5,140 249,125 Losses and loss expenses.......... (153,894) (33,001) (2,424) (8,015) (1,697) (199,031) Acquisition costs................. (52,940) (9,287) (795) (1,516) (1,758) (66,296) Operating costs................... (16,503) (4,393) (421) (976) (550) (22,843) --------- -------- ------- ------- ------- --------- Net underwriting income (loss).... $ (35,321) $ (4,238) $ 293 $ (914) $ 1,135 $ (39,045) ========= ======== ======= ======= ======= =========
The operating ratios for the 12 months ended December 31, 2000 and 1999, by line of business and in total, were as follows:
YEAR ENDED DECEMBER 31, 2000 ------------------------------------------------------------------------------ MEDICAL ACCIDENT CREDIT LIFE OTHER TOTAL -------- -------- -------- -------- -------- -------- Loss Ratio................................... 76.7% 91.0% 35.6% 86.4% 68.3% 79.1% Acquisition expense ratio.................... 33.1% 31.0% 53.5% 26.4% 46.6% 33.2% ----- ----- ---- ----- ----- ----- Loss and acquisition expense ratio........... 109.8% 122.0% 89.1% 112.8% 114.9% 112.3% ----- ----- ---- ----- ----- Operating expense ratio...................... 15.7% ----- Combined ratio............................... 128.0% -----
YEAR ENDED DECEMBER 31, 1999 ------------------------------------------------------------------------------ MEDICAL ACCIDENT CREDIT LIFE OTHER TOTAL -------- -------- -------- -------- -------- -------- Loss Ratio.................................... 81.9% 77.8% 61.6% 83.6% 33.0% 79.9% Acquisition expense ratio..................... 28.2% 21.8% 20.2% 15.8% 34.2% 26.6% ----- ---- ---- ---- ---- ----- Loss and acquisition expense Ratio............ 110.1% 99.6% 81.8% 99.4% 67.2% 106.5% ----- ---- ---- ---- ---- Operating expense ratio....................... 9.2% ----- Combined ratio................................ 115.7% -----
After rapid growth in 1999 in its medical portfolio, the Company recognized in the second quarter of 2000 that much of this business was not profitable business. Actions taken at that time included the centralizing of underwriting, the cessation of writing North American medical business sourced from the London office, strengthening the Company's terms of trade, effecting rate increases and being more selective on business accepted. As a result, gross premiums written on medical business declined 31% during the year. The Company will maintain its presence in the North American and Latin American markets but on a much more selective basis. It will also continue to take every opportunity to diversify its product range. Gross written premiums on accident business declined 18.6% to $54.1 million for the year ended December 31, 2000, in line with the Company's selectivity on writing new and renewal business. Adverse claims development, particularly on the Company's Norwegian portfolio, contributed to the increase in the loss and acquisition expense ratio from 99.6% in 1999 to 122.0% in 2000. Poor underwriting results across the two major lines of business contributed to the increase in the loss and acquisition ratio from 106.5% in 1999 to 112.3% in 2000. The 2000 results are comprised of three underwriting years, with the 2000 underwriting year contributing earned premium of $106.5 million, carrying a loss and acquisition ratio of 104.1%. The 1999 underwriting year contributed $117.8 million of earned premium with a loss and acquisition ratio of 105.4%. The 1998 underwriting 17 year contributed $3.7 million to net earned premium with $17.1 million of loss and acquisition expense attached. The operating expense ratios for the years ended December 31, 2000 and 1999 were calculated by expressing total administrative expenses net of corporate office expense, as a percentage of net premiums earned. Included in 2000 administrative expense is the provision of an $8.4 million legal reserve for the expected costs associated with resolving disputes in respect of certain risks ceded to and in some cases rescinded by the Company. GEOGRAPHIC SPREAD As a consequence of a reduction in premiums written, selectivity in business being written and growth in the partnership enterprise segment, more business was being sourced outside of the North American market in 2000 when compared to 1999. See Notes to the Consolidated Financial Statements. The distribution of gross written premiums for years ended December 31, 2000 and 1999, is as follows:
YEARS ENDED DECEMBER 31 ------------------- 2000 1999 -------- -------- Western Europe.............................................. 18.4% 21.2% North America............................................... 53.8% 63.5% Latin America............................................... 15.7% 9.8% Other....................................................... 12.1% 5.5% ----- ----- Total....................................................... 100.0% 100.0% ===== =====
PRODUCT MIX The distribution of gross premiums written by line of business for the years ended December 31, 2000 and 1999 is as follows:
YEARS ENDED DECEMBER 31, ------------------- 2000 1999 -------- -------- Medical..................................................... 71.0% 75.7% Personal Accident........................................... 22.0% 19.9% Credit...................................................... 1.4% 0.6% Life........................................................ 3.7% 2.1% Other....................................................... 1.9% 1.7% ----- ----- Total....................................................... 100.0% 100.0% ===== =====
MANAGEMENT FEE REVENUE The majority of management fee revenue in 2000 and 1999 consists of fees earned on those premiums managed for the Company's co-reinsurers. NET INVESTMENT INCOME Net investment income decreased by $0.6 million from $13.5 million in 1999 to $12.9 million in 2000. 18 The following table reflects the investment results for the year ended December 31, 2000:
NET ANNUALIZED NET REALIZED AVERAGE INVESTMENT EFFECTIVE INVESTMENT INVESTMENTS INCOME(1) YIELD LOSSES ----------- ---------- ---------- ------------ U.S DOLLARS IN THOUSANDS Investments...................................... $175,641 $11,523 6.6% $(2,538) Other investments................................ 13,794 434 3.1% -- Cash and cash equivalents........................ 23,430 967 4.1% -- -------- ------- ---- ------- Total............................................ $212,865 $12,924 6.1% $(2,538) ======== ======= ==== =======
------------------------ (1) Net investment income is net of investment-related expenses and income on premium receivable and funds held by ceding companies. The Company's investment portfolio in 2000 was reduced, in part, as a result of the share buy back and investment results were negatively impacted by realized losses from the sale of bonds that fell outside the Company's investment guidelines following their respective rating downgrades. The following table reflects the investment results for the year ended December 31, 1999:
NET ANNUALIZED NET REALIZED AVERAGE INVESTMENT EFFECTIVE INVESTMENT INVESTMENTS INCOME(1) YIELD LOSSES ----------- ---------- ---------- ------------ U.S DOLLARS IN THOUSANDS Investments...................................... $197,781 $11,528 5.8% $(1,960) Other investments(2)............................. 10,931 495 4.5% (14) Cash and cash equivalents........................ 26,889 1,492 5.5% -- -------- ------- --- ------- Total............................................ $235,601 $13,515 5.7% $(1,974) ======== ======= === =======
------------------------ (1) Net investment income is net of investment-related expenses and income on premium receivable and funds held by ceding companies. (2) Other investments include $7.8 million of equity investment and loans provided to three companies that are expected to generate or secure profitable reinsurance business for the Company. The Company's investment portfolio in 1999 was negatively impacted by a general decrease in prices in the U.S. bond markets, which resulted in net investment losses being realized on sales of fixed income securities during the year ADMINISTRATIVE EXPENSES AND TAXES Total administrative expenses, which includes personnel costs, professional service fees, interest expense and other expenses, increased by $14.1 million, or 55%, from $25.7million in 1999 to $39.8million in 2000. The majority of the increase was due to the Company establishing a legal reserve of $8.4 million for costs associated with resolving disputes in respect of certain contracts and its investment in the Direct Response Marketing and Bancassurance lines of business. The Company continued to incur significant expenses for professional services and for travel expenses in the development of its business. Personnel costs increased by $4.1 million from $9.0 million in 1999 to $13.1 million in 2000. The number of full time employees has increased from 121 at December 31, 1999 to 135 at December 31, 2000. The increase in employees was primarily in Direct Marketing, Bancassurance and in the centralized underwriting and claims operations. Professional service fees increased by $2.1 million from $8.2 million in 1999 to $10.3 million in 2000. Professional fees included $4.1 million in legal fees in respect of corporate compliance, 19 standardization of policy contracts and management agreements, acquisitions, forensic audits and legal disputes. Audit and accountancy costs of $2.0 million were incurred in audit, accounting, tax advisory and corporate reporting services. Consulting expenses of $4.1 million were incurred in actuarial support, computer systems improvements, recruitment, due diligence and corporate communications. Foreign exchange losses were $1.3 million in the 12 months ended December 31, 2000 compared to foreign exchange losses of $11 thousand for the 12 months ended December 31, 1999. These gains or losses are primarily unrealized and were incurred on the revaluation of assets and liabilities denominated in foreign currencies for reporting purposes. As the Company maintains a partial natural hedge, whereby foreign currency assets are held in the same currencies in which it must pay liabilities, the impact on cash flows from foreign exchange movements is reduced. Tax expense was nil for the year reflecting the losses reported. DISCONTINUED OPERATIONS Reference is made to Note 11 of Notes to Financial Statements concerning the divestiture, effective June 30, 2000, of the Company's Health Care Division. YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998 The Company reported a net loss of $42.0 million for 1999, compared to a net profit of $14.5 million for 1998. Included in the net loss for 1999 is $12.8 million of, primarily, expenses associated with the discontinued Health Care Division. As noted previously, the Health Care Division was divested, effective June 30, 2000 and amounts previously reported are now shown as part of discontinued operations. NET UNDERWRITING INCOME For the year ended December 31, 1999, the Company managed, on behalf of itself and its co-reinsurers, total premiums of $347.9 million, of which it placed $14.9 million with co-reinsurers and retroceded $19.8 million, resulting in $313.2 million net premiums written. For the year ended December 31, 1998, the Company managed, on behalf of itself and its co-reinsurers, total premiums of $224.2 million, of which it placed $24.3 million with co-reinsurers and retroceded $4.3 million, resulting in $195.6 million net premiums written. The amount placed with co-reinsurers declined to 4.3% of total premiums managed in 1999 compared to 10.8% in 1998, as the Company amended two of its co-reinsurance agreements to enable business from certain markets to be retroceded to the reinsurers. In addition, the Company had one large medical account in North America, contributing $65 million in premium managed, which was retained 100% by ESG. 20 Net premiums earned increased by 152% over 1998 due to the Company now being in its second full year of operation, leading to a higher earned to written percentage on normal business. In addition, the Company wrote two accounts during the year with total premium of $76.5 million that had accelerated earnings patterns resulting in all such premium being earned during 1999. Gross and net premiums written and net premiums earned for the 12 months ended December 31, 1999 and 1998 were as follows:
YEARS ENDED DECEMBER 31, ------------------- 1999 1998 -------- -------- U.S. DOLLARS IN MILLIONS Total premiums managed...................................... $347.9 $224.2 Amount placed with co-reinsurers............................ (14.9) (24.3) ------ ------ Gross premiums written...................................... 333.0 199.9 Retroceded.................................................. (19.8) (4.3) ------ ------ Net premiums written........................................ $313.2 $195.6 ====== ====== Net premiums earned......................................... $249.1 $ 98.8 ====== ======
Total premiums managed for the 12 months ended December 31, 1999 consisted of the following: - New Business--approximately $207 million, or 60.0%, of total premiums managed was generated from new business. Two new accounts contributed $76.5 million of managed premiums and these accounts are non-renewable in 2000. - Renewal Business--approximately $141 million, or 40.0%, of total premiums managed was generated from renewal business. This represents a renewal rate of 63% of risks managed in 1998. During 1999, the Company had reductions in gross premiums written on the 1998 underwriting year of $1.6 million, equivalent to 0.8% of gross premium written in 1998. This represents differences between estimates made at the time contracts are written and actual amounts as reported by ceding companies. Such changes are recorded in the period in which the actual amounts are determined. Underwriting results for the 12 months ended December 31, 1999 and 1998, by line of business and in total, were as follows:
YEAR ENDED DECEMBER 31, 1999 --------------------------------------------------------------- MEDICAL ACCIDENT CREDIT LIFE OTHER TOTAL -------- -------- -------- -------- -------- -------- U.S. DOLLARS IN THOUSANDS Gross premiums written................. $251,984 $66,514 $1,851 $6,934 $5,517 $333,000 Net premiums written................... 240,314 61,549 714 5,550 5,083 313,210 Net premiums earned.................... 188,016 42,443 3,933 9,593 5,140 249,125 Losses and loss expenses............... (153,894) (33,001) (2,424) (8,015) (1,697) (199,031) Acquisition costs...................... (52,940) (9,287) (795) (1,516) (1,758) (66,296) Operating costs........................ (16,503) (4,393) (421) (976) (550) (22,843) -------- ------- ------ ------ ------ -------- Net underwriting income (loss)......... $(35,321) $(4,238) $ 293 $ (914) $1,135 $(39,045) ======== ======= ====== ====== ====== ========
21
YEAR ENDED DECEMBER 31, 1998 --------------------------------------------------------------- MEDICAL ACCIDENT CREDIT LIFE OTHER TOTAL -------- -------- -------- -------- -------- -------- U.S. DOLLARS IN THOUSANDS Gross premiums written............... $119,157 $52,254 $12,346 $10,995 $5,120 $199,872 Net premiums written................. 117,353 50,814 11,910 10,558 4,943 195,578 Net premiums earned.................. 40,875 46,038 4,856 4,501 2,571 98,841 Losses and loss expenses............. (24,646) (29,003) (3,448) (3,408) (859) (61,364) Acquisition costs.................... (14,241) (10,207) (837) (523) (906) (26,714) Operating costs...................... (3,584) (4,036) (420) (534) (228) (8,802) -------- ------- ------- ------- ------ -------- Net underwriting income (loss)....... $ (1,596) $ 2,792 $ 151 $ 36 $ 578 $ 1,961 ======== ======= ======= ======= ====== ========
The operating ratios for the 12 months ended December 31, 1999 and 1998, by line of business and in total, were as follows:
YEAR ENDED DECEMBER 31, 1999 ------------------------------------------------------------------------------ MEDICAL ACCIDENT CREDIT LIFE OTHER TOTAL -------- -------- -------- -------- -------- -------- Loss Ratio.................................... 81.9% 77.8% 61.6% 83.6% 33.0% 79.9% Acquisition expense ratio..................... 28.2% 21.8% 20.2% 15.8% 34.2% 26.6% ----- ---- ---- ---- ---- ----- Loss and acquisition expense ratio............ 110.1% 99.6% 81.8% 99.4% 67.2% 106.5% ----- ---- ---- ---- ---- Operating expense ratio....................... 9.2% ----- Combined ratio................................ 115.7% =====
YEAR ENDED DECEMBER 31, 1998 ------------------------------------------------------------------------------ MEDICAL ACCIDENT CREDIT LIFE OTHER TOTAL -------- -------- -------- -------- -------- -------- Loss Ratio..................................... 60.3% 63.0% 71.0% 75.7% 33.4% 62.1% Acquisition expense ratio...................... 34.8% 22.2% 17.2% 11.6% 35.2% 27.0% ---- ---- ---- ---- ---- ---- Loss and acquisition expense ratio............. 95.1% 85.2% 88.2% 87.3% 68.6% 89.1% ---- ---- ---- ---- ---- Operating expense ratio........................ 8.9% ---- Combined ratio................................. 98.0% ====
The Company experienced rapid growth in 1999 in its medical portfolio, particularly in the North American market. The Company's London market office established in July 1998 had a full year of production and exceeded premium targets set by management. The Toronto office wrote one large medical contract for $65 million that led to a dramatic growth in written and earned premium for the medical line. The North American medical rates are increasing and more rigorous terms of trade are being accepted by ceding companies. The Company will maintain its presence in the North American market on a selective basis while taking every opportunity to diversify the product range. Accident business grew by 27% in 1999, with strong growth in the London market reflective of 1999 being the first full year of operation. The London market is more competitive than the Continental Europe market and this has contributed to the increase in the loss and acquisition ratio in 1999. In addition, during the fourth quarter, the Company added $3.4 million to reserves relating to adverse development on a large Continental Europe contract, following the receipt of accounting information from the ceding company in February 2000. Gross premium written from Credit business has declined by 85% in 1999. One three year contract in Latin America written in 1998 at $8 million was cancelled by the ceding company after twelve months with a resultant decrease in written premium of $5.3 million in 1999. Excluding the impact of 22 this account on both underwriting years, the Credit portfolio has grown by 64%. The Company expects to develop this line of business further in 2000. Gross premium from Life business declined by 37% in 1999 from $11.0 million to $6.9 million. Approximately $6.3 million of Life business written in Latin America in 1998 did not renew in 1999. Life business remains a core element of the ESG strategy. Additional underwriting and actuarial management has been recruited by the Company to enable expansion of this product line in 2000. Deterioration on two risks underwritten in Continental Europe has led to the loss on the account. Other business represents automobile warranty business ceded by a German company in which ESG made a 10% equity investment in 1998. In addition, property and casualty business written by the Company's subsidiary in Tbilisi, Georgia is included, on which the Company has a minimal risk retention. As indicated previously, poor underwriting results on the medical line contributed to the increase in the loss and acquisition ratio from 89.1% in 1998 to 106.7% in 1999. The 1999 results are comprised of two underwriting years, with the 1998 underwriting year contributing earned premium of $78.8 million, carrying a loss and acquisition ratio of 118.4%. The 1999 underwriting year contributed $170.7 million, carrying a loss and acquisition ratio of 101.3%. The operating expense ratios for the years ended December 31, 1999 and 1998, were calculated by expressing total administrative expenses net of corporate office expenses and health care division expenses, as a percentage of net premiums earned. For the year ended December 31, 1998, management fee revenue of $1.9 million was deducted from operating expenses due to the expense of administering the pool business of 1997 and prior underwriting years, which the Company previously managed as a reinsurance management services company. In addition, for the years ended December 31, 1999 and 1998, the Company deferred $1.3 million and $1.5 million respectively of expenses, which were identified by management as directly related to and, varying with, the volume of business generated. The deferral of such costs reflects a more appropriate matching of revenues with related expenses and improved the year-to-date combined ratios for years ended December 31, 1999 and 1998 by 0.5% and 1.5% respectively. GEOGRAPHIC SPREAD The Company has experienced significant growth in North America business in 1999 both through its Toronto underwriting office and its London market operations. The distribution of gross written premiums for years ended December 31, 1999 and 1998, is as follows:
YEARS ENDED DECEMBER 31, ---------------------- 1999 1998 -------- -------- Western Europe.............................................. 21.2% 30.9% North America............................................... 63.5% 46.2% Latin America............................................... 9.8% 14.9% Other....................................................... 5.5% 8.0% ----- ----- Total....................................................... 100.0% 100.0% ===== =====
23 PRODUCT MIX The distribution of gross premiums written by line of business for the years ended December 31, 1999 and 1998 was as follows:
YEARS ENDED DECEMBER 31, ---------------------- 1999 1998 -------- -------- Medical..................................................... 75.7% 59.6% Personal Accident........................................... 19.9% 26.1% Credit...................................................... 0.6% 6.2% Life........................................................ 2.1% 5.5% Other....................................................... 1.7% 2.6% ----- ----- Total....................................................... 100.0% 100.0% ===== =====
MANAGEMENT FEE REVENUE The majority of management fee revenue in 1999 and 1998 consists of fees earned on those premiums managed for the Company's co-reinsurers. During 1999, the Company adjusted downwards $1.0 million in estimated profit commissions due on pool underwriting years prior to 1998 following a re-evaluation of the pool results of those years. Management fee revenue in 1998 includes an upward revision in management fees on pool underwriting years prior to 1998 in the amount of $144 thousand. NET INVESTMENT INCOME Net investment income increased by $0.6 million from $12.9 million in 1998 to $13.5 million in 1999. The increase resulted from accelerated cash flows and more efficient management of short-term deposits. As of March 23, 2000, the Company's stock repurchase program has resulted in expenditure of $17.8 million of which $10.6 million was incurred in the fourth quarter of 1999. This will reduce investment income in 2000. The following table reflects the investment results for the year ended December 31, 1999:
NET ANNUALIZED NET REALIZED AVERAGE INVESTMENT EFFECTIVE INVESTMENT INVESTMENTS INCOME(1) YIELD LOSSES ----------- ---------- ---------- ------------ U.S. DOLLARS IN THOUSANDS Investments...................... $197,781 $11,528 5.8% $(1,960) Other investments(2)............. 10,931 495 4.5% (14) Cash and cash equivalents........ 26,889 1,492 5.5% -- -------- ------- --- ------- Total............................ $235,601 $13,515 5.7% $(1,974) ======== ======= === =======
------------------------ (1) Net investment income is net of investment-related expenses and income on premium receivable and funds held by ceding companies. (2) In addition to the $3.2 million of loans provided to COMED, a further $7.8 million of equity investment and loans has been provided to three companies that are expected to generate or secure profitable reinsurance business for the Company. The Company's investment portfolio in 1999 was negatively impacted by a general decrease in prices in the U.S. bond markets, which resulted in net investment losses being realized on sales of fixed income securities during the year. 24 The following table reflects the investment results for the 12 months ended December 31, 1998:
ANNUALIZED NET REALIZED AVERAGE NET INVESTMENT EFFECTIVE INVESTMENT INVESTMENTS INCOME(1) YIELD GAINS ----------- -------------- ---------- ------------ U.S. DOLLARS IN THOUSANDS Fixed maturity investments.... $218,383 $12,160 5.57% $2,162 Other investments............. 7,721 440 5.70% -- Cash and cash equivalents..... 13,516 330 2.44% -- -------- ------- ---- ------ Total......................... $239,620 $12,930 5.40% $2,162 ======== ======= ==== ======
------------------------ (1) Net investment income is net of investment-related expenses. The Company's investment portfolio in 1998 was positively affected by a general increase in prices in the U.S. bond markets, which allowed net investment gains to be realized on sales of fixed income securities during the year. ADMINISTRATIVE EXPENSES AND TAXES Total administrative expenses, which includes personnel costs, professional service fees, interest expense, other expenses and income taxes, increased by $12.5 million, or 95%, from $13.2 million in 1998 to $25.7 million in 1999. The Company continued to incur significant expenses for professional services and for travel expenses in the development of its business. Personnel costs increased by $5.0 million from $4.0 million in 1998 to $9.0 million in 1999. The number of employees has increased from 76 at December 31, 1998 to 121 at December 31, 1999, excluding the Company's operations in Tbilisi, Georgia. Professional service fees increased by $4.6 million from $3.6 million in 1998 to $8.2 million in 1999. Professional fees included $2.4 million in legal fees in respect of corporate compliance, standardization of policy contracts and management agreements, acquisitions and forensic audits. Audit and accountancy costs of $2.8 million were incurred in audit, accounting, tax advisory and corporate reporting services. Consulting expenses of $3.0 million were incurred in actuarial support, computer systems improvements, recruitment, due diligence and corporate communications. Foreign exchange losses were $11 thousand in the 12 months ended December 31, 1999 compared to foreign exchange gains of $141 thousand for the 12 months ended December 31, 1998. These gains or losses are primarily unrealized and were incurred on the revaluation of assets and liabilities denominated in foreign currencies for reporting purposes. As the Company maintains a partial natural hedge, whereby foreign currency assets are held in the same currencies in which it must pay liabilities, the impact on cash flows from foreign exchange movements is reduced. Taxes decreased by $0.5 million from $1.3 million in 1998 to $0.8 million in 1999. The reduction in taxes reflects the loss reported by the Company during 1999. The deferred tax asset of $0.8 million held by the Company at December 1998 has been written off as the Company considers recovery of the asset unlikely. LIQUIDITY AND CAPITAL RESOURCES As of December 31, 2000, total investments and cash were $212.2 million, compared to $221.5 million at December 31, 1999. All fixed maturity securities in the Company's investment portfolio are classified as available for sale and are carried at fair value. 25 The fixed maturity investment portfolios as of December 31, 2000 and 1999 were as follows:
AS AT DECEMBER 31, 2000 ----------------------------------------- AVERAGE FAIR DURATION MARKET CREDIT VALUE (YEARS) YIELD RATING -------- -------- -------- -------- U.S. DOLLARS IN THOUSANDS Corporate securities..................................... $ 71,382 3.0 6.6% AA U.S. treasury securities and obligations of U.S. Government corporations and agencies................... 38,127 2.4 6.1% AAA Asset-backed securities/Mortgage-backed securities....... 33,771 3.0 8.1% AAA Obligations of states and political subdivisions......... 18,753 3.0 7.3% AAA Foreign currency debt securities......................... 6,445 1.6 4.5% AAA -------- --- --- ---- Total in USD............................................. $168,478 2.6 6.5% AA ======== === === ====
AS AT DECEMBER 31, 1999 ----------------------------------------- AVERAGE FAIR DURATION MARKET CREDIT VALUE (YEARS) YIELD RATING -------- -------- -------- -------- U.S. DOLLARS IN THOUSANDS Corporate securities..................................... $102,355 3.0 7.2% A+ U.S. treasury securities and obligations of U.S. Government corporations and agencies................... 21,329 2.7 6.2% AAA Asset-backed securities/Mortgage-backed securities....... 23,486 1.0 7.8% AAA Obligations of states and political subdivisions......... 16,281 2.3 7.1% AA+ Foreign currency debt securities......................... 13,719 3.7 4.7% AAA -------- --- --- ---- Total.................................................... $177,170 2.7 7.0% AA ======== === === ====
The Company's investment policy objective is to maximize long-term investment returns while maintaining a liquid, high-quality portfolio. To this end, the investment policy requires that the portfolio have an average credit quality rating of AA, with no more than 3% of the portfolio invested in the securities of a single issuer (other than issues of sovereign governments with a rating of AA or better), and a target duration of 2.75 years. The Company's investment portfolio as of December 31,2000 and 1999 complies with the adopted investment policy and guidelines. In 2001, the Company will continue to follow its investment policy and guidelines while seeking to improve long-term value by continuing to invest in selected strategic investments in accordance with its current commitments. A strategic investment is defined as an investment in a reinsurance-related enterprise, ceding company or distribution channel that is expected to generate or secure additional profitable business for the Company. To date, ESG has invested $2.0 million and acquired an 85% ownership interest in IMEDI L International, a provider of general insurance products, based in Tbilisi, Georgia. This Company is consolidated within the Company's operating results. Additionally, equity investments and loans totaling $17.7 million were extended primarily to other companies or associations with whom ESG has operating relationships. Operating activities provided net cash of $22.1 million for the year ended December 31, 1999 and used cash of $1.5 million for the year 2000. Cash flows from operations in future years may differ substantially from net income. As the Company only began to assume reinsurance risks for its own account in 1997, the Company has built up substantial loss reserves to meet future loss payments under reinsurance contracts. As reinsurance contracts mature, the Company will be required to pay out a higher percentage of incurred losses in loss payments, which affect cash flows. 26 The Company initiated a stock repurchase program in May 1999 to actively manage its capital base. As of March 15, 2001, the Company has repurchased 2,727,591 shares of its common stock, equivalent to 20.5% of the outstanding shares of the Company under its Common Stock Repurchase Program. The average purchase price was $6.74. The Company can buy a further 968,600 shares of its common stock under the existing program. Reinsurance balances receivable decreased from $276.1 million as at December 31, 1999 to $241.6 million as at December 31, 2000. The decrease was due to the decline in gross reinsurance premiums written by the Company, which are recognized at the inception of the reinsurance contract, based upon information received from intermediaries and ceding companies. The Company compares estimated written premiums to actual premiums as reported by ceding companies on a monthly basis and differences are recorded in the period in which the actual amounts are determined. Prepaid reinsurance premiums decreased from $9.1 million as at December 31, 1999 to $5.4 million as at December 31, 2000. During the year, the Company retroceded 13.6% of its gross written premiums to reinsurers compared to 6.3% in 1999, as the Company amended two of its co-reinsurance agreements to enable business from certain markets to be retroceded to the reinsurers. The Company has maintained the same levels of excess of loss protection in 2000 as was purchased in 1999. Reinsurance funds recoverable on incurred losses increased from $11.5 million as at December 31, 1999 to $15.6 million as at December 31, 2000. The increase was due to additional losses being incurred above the Company's net retention levels that enable the Company to make recoveries from its excess of loss reinsurers, plus the additional quota share cessions to two of its retrocessionaires. Deferred acquisition costs decreased from $57.8 million as at December 31, 1999 to $46.6 million as at December 31, 2000. Acquisition costs, consisting principally of commissions and brokerage expenses incurred at the time a contract or policy is issued, are deferred and amortized over the period in which the related premiums are earned. The decrease was a function of the decline in written premiums over the year. At December 31, 2000, reserves for unpaid losses and loss expenses were $179.6 million compared to $136.9 million at December 31, 1999. This increase was directly the result of claims notifications received and reserve strengthening done in the later half of the year. At December 31, 2000, unearned premium reserves were $148.1 million compared to $181.1 million at December 31, 1999. Unearned premium reserves are established to cover the unexpired period of contracts of reinsurance underwritten by the Company. At December 31, 2000, acquisition costs payable were $64.6 million compared to $73.1 million at December 31, 1999. The balance represents acquisition expenses due on gross reinsurance premiums written by the Company and is consistent with the decrease in written premiums. Shareholders' equity as of December 31, 2000 was $113.6 million, compared to $176.8 million at December 31, 1999. The major factor causing the reduction in shareholders' equity in the 12-month period was the Company's net operating losses. Book value per common share declined to $9.64 as of December 31, 2000 from $15.24 as of December 31, 1999. The Company expects that its financial and operational needs for the foreseeable future will be met by funds generated from operations and the liquidity of its investment portfolio. 27 As of December 31, 2000, the Company had the following material commitments for operating leases and employment contracts:
TOTAL COMMITMENTS IN U.S. DOLLARS ---------------------------------------------------------- LESS EMPLOYEE LEASE SUBLEASE COMMITMENTS YEARS ENDING DECEMBER 31, 2000 COMMITMENTS INCOME NET NET TOTAL ------------------------------ ----------- -------- -------- ----------- -------- (IN THOUSANDS) 2001......................... $1,281 $294 $ 987 $2,095 $3,082 2002......................... 1,058 213 845 897 1,742 2003......................... 793 38 755 117 872 2004......................... 558 -- 558 -- 558 2005......................... 353 -- 353 -- 353 2006 to 2012................. 654 -- 654 -- 654 ------ ---- ------ ------ ------ Total...................... $4,697 $545 $4,152 $3,109 $7,261 ====== ==== ====== ====== ======
In support of its business, the Company enters into Letters of Credit and Trust Account arrangements with ceding companies. As at December 31, 2000, the Company had in total $95.8 million of outstanding Letters of Credit and Trust Accounts of which $73.4 million related to Letters of Credit issued and $22.4 million was issued in Trust Accounts. These arrangements were secured against the Company's fixed maturity investment portfolio. Effective January 1, 2001, the total Letters of Credit issued was decreased from $73.4 million to $50.1 million due to historical letters of credit expiring December 31, 2000. Further, in accordance with local regulatory requirements, the Company placed $20 million in a Trust Agreement in February, 2001. On November 13, 2000, the Company was notified that Standard & Poor's lowered the long term counterparty credit and insurer financial strength ratings of the Company's reinsurance subsidiaries from BB+ to B+ citing concerns over poor operating results. An upward ratings adjustment will be a function of the Company's successful execution of its business strategy and the resultant improvement in operating earnings. To date, there has been no material impact from the rating change on the Company's ability to secure new and renewal business, but the Company cannot say with certainty that there will be no impact in the future. EXPOSURE MANAGEMENT The Company manages its underwriting risk exposures primarily through an excess of loss reinsurance program. This program generally provides limits up to a maximum of $30 million per occurrence, with a minimum attachment point generally of $250 thousand. CURRENT DEVELOPMENTS The Company announced in a press release dated January 31, 2001, that Alasdair Davis will assume the role of Chief Executive Officer at the annual general meeting of shareholders in May 2001. John C Head III, the current Chief Executive Officer will remain as Chairman of the Board. ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS 133"). This statement is effective for all fiscal quarters of fiscal years beginning after June 15, 2000. The Company believes that it does not currently enter into any transactions that are covered by this statement and therefore, the Company does not anticipate any significant change to its current financial reporting. 28 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK MARKET RISK The Company is subject to market risk arising from the potential change in value of its various financial instruments. These changes may be due to fluctuations in interest rates or foreign currency rates, or both in the case of foreign currency investments. The Company monitors its exposure to interest rate and currency rate risk on a quarterly basis and currently does not believe that the use of derivatives to manage such risk is necessary. The Company intends to reevaluate the need for a formal hedging strategy on a periodic basis, and may determine that such a strategy, including the use of derivative instruments, is appropriate in the future. INTEREST RATE RISK The largest source of market risk for the Company is interest rate risk on its portfolio of fixed maturity investments, especially fixed rate instruments. In addition, the credit worthiness of the issuer, relative values of alternative investments, liquidity and general market conditions may affect fair values of interest rate sensitive instruments. The Company's general strategy with respect to fixed maturity securities is to invest in high quality securities while maintaining diversification to avoid significant concentrations in individual issuers' industry segments or countries. Generally, it is expected that an increase in market interest rates will cause a decline in the value of the Company's investment portfolio, whereas a decrease in rates may cause an increase in value. The following table shows the approximate effect on the value of the Company's fixed maturities investment portfolio, based on hypothetical changes in market interest rates for the year ended December 31, 2000 and 1999:
-150 -100 -50 +50 +100 +150 BASIS BASIS BASIS MARKET BASIS BASIS BASIS POINTS POINTS POINTS VALUE POINTS POINTS POINTS -------- -------- -------- -------- -------- -------- -------- U.S. DOLLARS IN THOUSANDS December 31, 2000.............. $176,327 $173,668 $171,052 $168,478 $165,944 $163,450 $160,994 December 31, 1999.............. $184,558 $182,040 $179,578 $177,170 $174,814 $172,508 $170,252
The changes in portfolio values shown were ascertained by calculating the market yield of each bond given its actual market price at December 31, 2000 and 1999, raising or lowering each bond's yield by the hypothetical changes in market interest rates indicated above and, then calculating the resulting prices and the resulting aggregate market values. The modeled yield changes are assumed to occur instantaneously and equally across the yield curve. Price changes of floating rate bonds were calculated assuming coupons adjusted by the modeled amounts at their next scheduled reset date. Effects on portfolio value of prepayment related interest rate changes in the case of mortgage-backed securities are DE MINIMIS. The values indicated above are estimates and are necessarily based on various assumptions that are subjective in nature. Accordingly, the actual impact of changes in market rates on the Company's investment portfolio may be significantly greater or less than those indicated above. FOREIGN CURRENCY RISK The Company's functional currency is the U.S. dollar. However, the Company writes reinsurance business in numerous geographic regions and currencies, giving rise to the risk that the ultimate settlement of receivables and payables on reinsurance transactions will differ from the amounts currently recorded as assets and liabilities in the financial statements. The Company intends to hold investments in currencies in which it will collect premiums and pay claims, thus creating a partial 29 natural hedge against exchange rate fluctuations. The Company believes that its exposure to foreign currency risk is not material. INFLATION Inflation has not had a material impact on the Company's operations for any of the three years presented. The Company writes reinsurance in Latin America which has experienced periods of high inflation. However, it is possible that future inflationary conditions may impact subsequent accounting periods. THE EURO On January 1, 1999, a single currency, the "Euro," was adopted as the national currency of the 11 participating countries in the European Monetary Union, including Germany and Ireland, two of the countries in which the Company operates and in which the Company maintains a significant presence. ESG's German and Irish subsidiaries will not be required to use the Euro for accounting purposes prior to January 1, 2002. Due to uncertainties related to the Euro conversion, the impact of the conversion is not known. To date, the impact of the conversion has had no material impact on the Company's operations, accounting systems or financial reporting. 30 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ESG RE LIMITED CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, -------------------------- 2000 1999 ------------ ----------- U.S. DOLLARS IN THOUSANDS EXCEPT SHARE DATA ASSETS Investments available for sale, at fair value (cost: $166,513 and $184,767).................................... $ 168,478 $181,155 Cash and cash equivalents................................... 26,032 28,278 Other investments........................................... 17,736 12,116 --------- -------- Total investments and cash.................................. 212,246 221,549 Accrued investment income................................... 3,240 3,367 Management fees receivable.................................. 713 1,303 Reinsurance balances receivable............................. 241,587 276,112 Reinsurance recoverable on incurred losses.................. 15,633 11,462 Funds held by ceding companies.............................. 18,432 15,541 Prepaid reinsurance premiums................................ 5,432 9,108 Deferred acquisition costs.................................. 46,611 57,807 Other assets................................................ 6,281 6,071 Cash and cash equivalents held in a fiduciary capacity...... 4,619 3,364 --------- -------- TOTAL ASSETS................................................ $ 554,794 $605,684 ========= ======== LIABILITIES Unpaid losses and loss expenses............................. $ 179,614 $136,935 Unearned premiums........................................... 148,124 181,127 Acquisition costs payable................................... 64,604 73,055 Reinsurance balances payable................................ 30,511 26,025 Payable for securities purchased............................ -- 241 Accrued expenses, accounts payable, and other liabilities ($85 and $125 due to related parties)..................... 13,756 8,122 Fiduciary liabilities....................................... 4,619 3,364 --------- -------- Total liabilities........................................... 441,228 428,869 --------- -------- Commitments and contingencies............................... -- -- --------- -------- SHAREHOLDERS' EQUITY Preference shares, 50,000,000 shares authorized; no shares issued and outstanding for 2000 and 1999.................. -- -- Class B common shares, 100,000,000 shares authorized; no shares issued and outstanding for 2000 and 1999........... -- -- Common shares, par value $1 per share; 100,000,000 shares authorized; 11,777,086 shares issued and outstanding for 2000 and 11,598,799 shares issued and outstanding for 1999...................................................... 11,777 11,599 Additional paid-in capital.................................. 207,646 211,225 Accumulated other comprehensive income: Foreign currency translation adjustments.................. (5,331) (1,702) Unrealized (losses) gains on securities (net of tax of $-- and $--)................................................ 1,965 (3,612) --------- -------- Accumulated other comprehensive income...................... (3,366) (5,314) --------- -------- Retained earnings (deficit)................................. (102,491) (40,695) --------- -------- Total shareholders' equity.................................. 113,566 176,815 --------- -------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY.................. $ 554,794 $605,684 ========= ========
The accompanying notes are an integral part of the consolidated financial statements. 31 ESG RE LIMITED CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, ------------------------------------------ 2000 1999 1998 ------------ ------------ ------------ U.S. DOLLARS IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA REVENUES Net premiums written..................................... $ 211,886 $ 313,210 $ 195,578 Change in unearned premiums.............................. 24,734 (64,085) (96,737) ---------- ---------- ---------- Net premiums earned...................................... 236,620 249,125 98,841 Management fee revenue................................... 1,846 2,128 1,894 Net investment income (includes expenses of $397, $495 and $549 for related parties).......................... 12,924 13,515 12,930 Gain (loss) on equity investments........................ 180 (205) -- Net realized investment (losses) gains................... (2,538) (1,974) 2,162 ---------- ---------- ---------- 249,032 262,589 115,827 ---------- ---------- ---------- EXPENSES Losses and loss expenses................................. 187,241 199,031 61,364 Acquisition costs........................................ 78,566 66,296 26,714 Personnel costs.......................................... 13,085 8,993 4,352 Professional service fees (includes expenses of $--, $-- and $378 for related parties).......................... 10,268 8,166 3,599 Other expenses........................................... 16,490 8,510 4,014 ---------- ---------- ---------- 305,650 290,996 100,043 ---------- ---------- ---------- (LOSS) INCOME FROM CONTINUING OPERATIONS BEFORE TAXES.... (56,618) (28,407) 15,784 Income tax expense....................................... -- 815 1,262 ---------- ---------- ---------- INCOME (LOSS) FROM CONTINUING OPERATIONS................. (56,618) (29,222) 14,522 Net loss from discontinued operations.................... (5,178) (12,772) -- ---------- ---------- ---------- NET (LOSS) INCOME........................................ $ (61,796) $ (41,994) $ 14,522 ========== ========== ========== PER SHARE DATA Basic net income (loss) per share from continuing operations............................................. $ (4.79) $ (2.20) $ 1.04 Diluted net income (loss) per share from continuing operations............................................. $ (4.79) $ (2.20) $ 1.03 ========== ========== ========== Basic net income (loss) per share........................ $ (5.23) $ (3.17) $ 1.04 Diluted net income (loss) per share...................... $ (5.23) $ (3.17) $ 1.03 ========== ========== ========== WEIGHTED AVERAGE OF COMMON SHARES OUTSTANDING Basic.................................................. 11,809,000 13,260,214 13,923,799 Diluted................................................ 11,809,000 13,260,214 14,076,443 ========== ========== ========== Dividends declared per share............................. $ .24 $ .32 $ .30 ========== ========== ==========
The accompanying notes are an integral part of the consolidated financial statements. 32 ESG RE LIMITED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, ------------------------------- 2000 1999 1998 --------- -------- -------- U.S. DOLLARS IN THOUSANDS COMMON SHARES (PAR VALUE) Balance at January 1........................................ $ 11,599 $ 13,924 $ 13,924 Shares retired during year.................................. (393) (2,334) -- Issuance of shares to employees............................. 571 9 -- --------- -------- -------- Balance at December 31...................................... 11,777 11,599 13,924 --------- -------- -------- ADDITIONAL PAID-IN CAPITAL Balance at January 1........................................ 211,225 226,216 225,954 Shares retired during year.................................. (1,643) (14,195) -- Directors' fees taken as stock options...................... 173 232 347 Dividends................................................... (2,859) (1,072) -- Additional offering costs................................... -- -- (85) Issuance of shares to employees............................. 750 44 -- --------- -------- -------- Balance at December 31...................................... 207,646 211,225 226,216 --------- -------- -------- ACCUMULATED OTHER COMPREHENSIVE INCOME Balance at January 1........................................ (5,314) 60 202 Foreign currency translation adjustments, net of tax........ (3,629) (1,128) (606) Unrealized (losses) gains on securities, net of tax......... 5,577 (4,246) 464 --------- -------- -------- Balance at December 31...................................... (3,366) (5,314) 60 --------- -------- -------- RETAINED (DEFICIT) EARNINGS Balance at January 1........................................ (40,695) 4,641 (5,705) Net (loss) income........................................... (61,796) (41,994) 14,522 Dividends................................................... -- (3,342) (4,176) --------- -------- -------- Balance at December 31...................................... (102,491) (40,695) 4,641 --------- -------- -------- TOTAL SHAREHOLDERS' EQUITY.................................. $ 113,566 $176,815 $244,841 ========= ======== ========
The accompanying notes are an integral part of the consolidated financial statements. 33 ESG RE LIMITED CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, --------------------------------- 2000 1999 1998 --------- --------- --------- U.S. DOLLARS IN THOUSANDS CASH FLOWS FROM OPERATING ACTIVITIES Net (loss) income........................................... $ (61,796) $ (41,994) $ 14,522 Adjustments to reconcile net (loss) income to net cash provided by (used in) operating activities Depreciation and amortization............................. 1,642 1,773 252 Realized investment losses (gains)........................ 2,805 1,974 (2,162) Amortization of premiums and discounts.................... -- 89 200 Bad debt provisions....................................... 740 3,416 -- Non-cash compensation expenses............................ 1,506 285 347 Changes in assets and liabilities: Accrued investment income................................. 127 262 (3,192) Management fees receivable................................ 590 1,861 95 Reinsurance balances receivable........................... 34,525 (107,838) (142,489) Reinsurance recoverable on incurred losses................ (4,171) (8,701) (2,364) Funds held by ceding companies............................ (2,891) (11,949) (3,592) Prepaid reinsurance premiums.............................. 3,676 (6,832) (1,976) Deferred acquisition costs................................ 11,196 (20,182) (33,478) Deferred tax asset........................................ -- 843 (55) Unpaid losses and loss expenses........................... 42,679 92,556 36,533 Unearned premiums......................................... (33,003) 69,243 99,716 Acquisition costs payable................................. (8,451) 27,568 35,152 Reinsurance balances payable.............................. 4,485 18,911 7,114 Accrued expenses and accounts payable..................... 5,634 2,195 (2,579) Other assets and liabilities.............................. (816) (1,329) (1,065) --------- --------- --------- NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES......... (1,523) 22,151 979 --------- --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES Cost of investments acquired--available for sale............ (209,647) (301,290) (436,239) Proceeds from sale of investments--available for sale....... 223,084 325,129 445,305 Change in short-term investments............................ -- -- 11,913 Purchases of fixed assets................................... (1,314) (2,686) (967) Purchases of intangible assets.............................. -- (958) (57) Funding of other investments................................ (7,940) (10,067) (5,917) --------- --------- --------- NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES......... 4,183 10,128 14,038 ========= ========= ========= CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from issuance of shares............................ -- -- -- Net change in short-term debt............................... -- -- -- Repurchase of common shares................................. (2,036) (16,529) -- Additional offering costs................................... -- -- (85) Dividends paid.............................................. (2,870) (4,414) (4,177) --------- --------- --------- NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES......... (4,906) (20,943) (4,262) ========= ========= ========= EFFECT OF EXCHANGE RATE CHANGES ON CASH..................... -- -- (9) --------- --------- --------- Net (decrease) increase in cash............................. (2,246) 11,336 10,746 Cash and cash equivalents at January 1...................... 28,278 16,942 6,196 --------- --------- --------- Cash and cash equivalents at December 31.................... $ 26,032 $ 28,278 $ 16,942 ========= ========= ========= SUPPLEMENTAL CASH FLOW INFORMATION Cash transactions Interest paid............................................. $ 6 $ 17 $ 8 Income taxes paid......................................... $ -- $ 496 $ 40 --------- --------- ---------
The accompanying notes are an integral part of the consolidated financial statements. 34 ESG RE LIMITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
YEARS ENDED DECEMBER 31, ------------------------------- 2000 1999 1998 --------- -------- -------- U.S. DOLLARS IN THOUSANDS Net (loss) income........................................... $ (61,796) $(41,994) $14,522 --------- -------- ------- Other Comprehensive income, net of tax: Foreign currency translation adjustments.................. (3,629) (1,128) (606) Unrealized (losses) gains on securities (net of tax of $160, $-- and $172)..................................... 3,039 (6,220) 2,626 Less reclassification adjustment for losses (gains) included in net income, (net of tax of $--, $-- and $11).................................................... 2,538 1,974 (2,162) --------- -------- ------- Other comprehensive (loss) income........................... 1,948 (5,374) (142) --------- -------- ------- Comprehensive (loss) income................................. $ (59,848) $(47,368) $14,380 ========= ======== =======
The accompanying notes are an integral part of the consolidated financial statements. 35 ESG RE LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE YEARS ENDED DECEMBER 31, 2000, 1999, 1998 1. ORGANIZATION AND BUSINESS ESG Re Limited ("the Company") was incorporated under the laws of Bermuda on August 21, 1997. Its principal activities conducted through its subsidiaries, are to provide accident, health, credit, life and special risk reinsurance and to provide underwriting management services for these lines. The consolidated financial statements include the accounts of the Company and its majority owned subsidiaries. All material intercompany balances and transactions have been eliminated in consolidation. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The Company's consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP"). The Company's significant accounting policies include the following: (A) PREMIUM REVENUES Premiums written are estimated and recognized at the inception of the reinsurance contract, based upon information received from intermediaries and ceding companies. The Company compares estimated written premiums to actual premiums as reported by ceding companies on a periodic basis. The timeliness and frequency of ceding company reports vary considerably by ceding company, line of business and geographic area, therefore the actual ultimate premium written may not be known with certainty for prolonged periods. Differences between such estimates and actual amounts as reported by ceding companies are recorded in the period in which the actual amounts are determined. The reinsurance contracts entered into by the Company are primarily of short duration. Premiums written are recognized as earned over the coverage period in proportion to the amount of protection provided. Unearned premium reserves are established to cover the unexpired contract period. (B) RESERVE FOR LOSSES AND LOSS EXPENSES The reserve for unpaid losses and loss adjustment expenses includes an estimate of reported case reserves and an estimate for losses incurred but not reported. Case reserves are estimated based on ceding company reports and other data considered relevant to the estimation process. The liability for losses incurred but not reported is based to a large extent on the expectations of ceding companies about ultimate loss ratios at the inception of the contracts, supplemented by industry experience and the Company's specific historical experience where available. As the Company has limited specific historical experience on a significant number of its programs on which to base its estimate of losses incurred but not reported, its reliance on ceding company expectations and industry experience is necessarily increased, which increases the uncertainty involved in the loss estimation process. The reserves as established by management are reviewed periodically, and adjustments are made in the periods in which they become known. Although management believes that an adequate provision has been made for the liability for losses and loss expenses, based on all available information, there can be no assurance that the ultimate losses will not differ significantly from the amounts provided. (C) INVESTMENTS Fixed maturity securities are classified as available for sale and are reported at estimated fair value. Investments that are available for sale are expected to be held for an indefinite period but may be sold depending on interest rates and other considerations. Other investments over which the Company exercises significant influence are accounted for under the equity method. Otherwise these 36 ESG RE LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE THREE YEARS ENDED DECEMBER 31, 2000, 1999, 1998 investments are accounted for at cost. Unrealized investment gains and losses on investments available for sale, net of applicable deferred income tax, are reported as a separate component of "accumulated other comprehensive income". Realized gains or losses on sale of investments are determined on the basis of average cost. The carrying values of investments available for sale and other investments are adjusted for impairments in value that are considered to be other than temporary. (D) DEFERRED ACQUISITION COSTS Costs relating to the production of new business (primarily commissions and certain costs of marketing) are deferred and included in the deferred acquisition cost asset to the extent that such costs are recoverable from future related policy revenues. The deferred acquisition costs are being amortized over the periods in which the related premiums are earned. Such deferred costs are reviewed to determine if they are recoverable from future income, including investment income, and, if not considered recoverable, are charged to expense. (E) REINSURANCE PREMIUMS CEDED Reinsurance premiums ceded are reported as prepaid reinsurance premiums and amortized over the respective contract or policy periods in proportion to the amount of insurance protection provided. Commissions on reinsurance ceded are deferred over the terms of the contracts of reinsurance to which they relate and amortized in proportion to the amount of insurance protection provided. (F) MANAGEMENT FEE REVENUE Management fee revenue consists primarily of fees earned as compensation for underwriting and managing the reinsurance portfolio on behalf of the Company's co-reinsurers. These fees are estimated and recognized at the inception of the contracts with the co-reinsurers and amortized over the life of the contracts. (G) INCOME TAXES The Company and its subsidiaries file income tax returns as required by the laws of each country in which they operate. The Company accounts for income tax expenses and liabilities under the asset and liability method in accordance with Statement of Financial Accounting Standards Board ("SFAS") No. 109, "Accounting for Income Taxes." Deferred income taxes arise from the recognition of temporary differences between income reported for financial statement purposes and income for income tax purposes. These deferred taxes are measured by applying currently enacted tax rates. In addition, SFAS No. 109 requires the recognition of future benefits, such as for net operating loss carryforwards, to the extent that realization of such benefits is more likely than not. (H) FOREIGN CURRENCY TRANSLATION The functional and reporting currency of the Company is U.S. dollars. Foreign currency receivables or payables that are denominated in a currency other than U.S. dollars are translated into U.S. dollars at the rates of exchange in effect at the balance sheet date. Revenues and expenses are translated into U.S. dollars using weighted average exchange rates for the period. The resulting exchange gains or losses are included in the results of operations. Exchange gains and losses related to the translation of investments available for sale are included in the net unrealized appreciation (depreciation) of investments, net of deferred income taxes, as a separate component of "accumulated other comprehensive income." Assets and liabilities related to foreign operations are translated into U.S. dollars at the exchange rate in effect at the balance sheet date; revenues and expenses are translated 37 ESG RE LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE THREE YEARS ENDED DECEMBER 31, 2000, 1999, 1998 into U.S. dollars using weighted average exchange rates for the period. Gains and losses resulting from translating foreign currency financial statements, net of deferred income taxes, are excluded from income and included as a separate component of "accumulated other comprehensive income." (I) EARNINGS PER SHARE Basic earnings per share are computed by dividing net income by the weighted average number of common shares outstanding. Diluted earnings per common share reflect the maximum dilution that would have resulted from the exercise of stock options and warrants to purchase common shares. Diluted earnings per common share are computed by dividing net income by the weighted average number of common shares outstanding and the dilutive potential common shares during the period of calculation. (J) STOCK-BASED COMPENSATION SFAS No. 123, "Accounting for Stock-Based Compensation" defines a fair value based method of accounting for stock-based employee compensation plans. Under SFAS No. 123, companies are encouraged, but are not required, to adopt the fair value method for all employee awards granted. Companies are permitted to account for such transactions under Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," but must disclose in a note to the financial statements, pro forma net income and earnings per share as if SFAS No. 123 had been applied. The Company accounts for stock-based compensation under APB No. 25 and provides the fair value method disclosures required by SFAS No. 123. (K) CASH AND CASH EQUIVALENTS For purposes of the consolidated statement of cash flows, the Company considers all time deposits and commercial paper with original maturity dates of 90 days or less to be cash equivalents. (L) USE OF ESTIMATES The preparation of financial statements in accordance with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period as well as the disclosure of such amounts. Actual results, particularly for premiums written, premiums earned and loss reserves could materially differ from those estimates and assumptions. (M) FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying value of the of the Company's investments approximates their fair value and is based on quoted market prices. Due to the uncertainty with respect to both the timing and amount of the proceeds to be realized from the Company's other investments, it is not practicable to determine the fair value of these other investments. The carrying values of other financial instruments, including cash and cash equivalents, accrued investment income, and other receivables and payables approximate their estimated fair value due to the short term nature of the balances. (N) ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). This statement is effective for all fiscal quarters of fiscal years beginning after June 15, 2000. As of December 31, 2000, the Company had no transactions that are covered by this statement. 38 ESG RE LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE THREE YEARS ENDED DECEMBER 31, 2000, 1999, 1998 3. INVESTMENTS The Company's investment portfolio at December 31, 2000 and 1999 is comprised of the following:
AS AT DECEMBER 31, ------------------- 2000 1999 -------- -------- U.S. DOLLARS IN THOUSANDS Fixed maturities available for sale..................... $168,478 $177,170 Equities................................................ -- 3,985 -------- -------- Total................................................... $168,478 $181,155 ======== ========
(A) FIXED MATURITIES AND EQUITIES The amortized cost, fair value and gross unrealized gains and losses of fixed maturity investments and equity investments as of December 31, 2000 and 1999 are presented in the tables below:
AS AT DECEMBER 31, 2000 ----------------------------------------------- COST OR GROSS GROSS ESTIMATED AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE --------- ---------- ---------- --------- U.S. DOLLARS IN THOUSANDS Corporate securities................................ $ 70,003 $1,562 $183 $ 71,382 U.S. treasury securities............................ 37,402 726 -- 38,128 Asset-backed securities/Mortgage-backed securities........................................ 33,722 89 40 33,771 Obligations of states and political subdivisions.... 18,263 490 -- 18,753 Foreign currency debt securities.................... 7,123 -- 679 6,444 Equity Investments.................................. -- -- -- -- -------- ------ ---- -------- Total............................................... $166,513 $2,867 $902 $168,478 ======== ====== ==== ========
AS AT DECEMBER 31, 1999 ----------------------------------------------- COST OR GROSS GROSS ESTIMATED AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE --------- ---------- ---------- --------- U.S. DOLLARS IN THOUSANDS Corporate securities................................ $105,581 $ 405 $3,631 $102,355 U.S. treasury securities............................ 21,417 233 321 21,329 Asset-backed securities/Mortgage-backed securities........................................ 23,453 327 294 23,486 Obligations of states and political subdivisions.... 16,481 103 303 16,281 Foreign currency debt securities.................... 13,850 52 183 13,719 Equity investments.................................. 3,985 -- -- 3,985 -------- ------ ------ -------- Total............................................... $184,767 $1,120 $4,732 $181,155 ======== ====== ====== ========
39 ESG RE LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE THREE YEARS ENDED DECEMBER 31, 2000, 1999, 1998 (B) MATURITY DISTRIBUTION The amortized cost and fair value of fixed maturities by contractual maturity are shown in the following table:
AS AT DECEMBER 31, 2000 -------------------- AMORTIZED FAIR COST VALUE --------- -------- U.S. DOLLARS IN THOUSANDS Fixed maturities available for sale Due in one year or less............................... $ 2,533 $ 2,539 Due after one year through five years................. 78,882 79,481 Due after five years through ten years................ 26,210 25,023 Due after ten years................................... 25,166 27,664 Mortgage-backed securities /Asset-backed securities..... 33,722 33,771 -------- -------- Total................................................... $166,513 $168,478 ======== ========
Proceeds from the sales of investments available for sale for the years ended December 31, 2000 and 1999 were $223.1 million and $325.1 million, respectively. Realized investment gains and losses for the years ended December 31, 2000, and 1999 were as follows:
FOR THE YEAR ENDED DECEMBER 31, ------------------- 2000 1999 -------- -------- U.S. DOLLARS IN THOUSANDS Gross realized gains...................................... $ 779 $ 460 Gross realized losses..................................... (3,317) (2,434) ------- ------- Total net realized gains (losses)......................... $(2,538) $(1,974) ======= =======
(C) CHANGE IN NET UNREALIZED (LOSSES) GAINS ON INVESTMENTS
AS OF DECEMBER 31, ------------------------------ 2000 1999 1998 -------- -------- -------- U.S. DOLLARS IN THOUSANDS Change in unrealized gains on investments, net of deferred taxes, included in other comprehensive income: Fixed maturities.......................................... $5,577 $(6,220) $2,787 Deferred taxes............................................ -- -- (172) ------ ------- ------ Total....................................................... $5,577 $(6,220) $2,615 ====== ======= ======
40 ESG RE LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE THREE YEARS ENDED DECEMBER 31, 2000, 1999, 1998 (D) NET INVESTMENT INCOME The components of net investment income are presented in the table below:
YEARS ENDED DECEMBER 31, ------------------------------ 2000 1999 1998 -------- -------- -------- U.S. DOLLARS IN THOUSANDS Interest on fixed maturities................................ $11,966 $12,335 $12,813 Interest on other investments............................... 434 495 126 Interest on cash and cash equivalents....................... 654 1,274 608 Other....................................................... 313 218 36 ------- ------- ------- Total investment income..................................... 13,367 14,322 13,583 Investment expenses......................................... (443) (807) (653) ------- ------- ------- Total....................................................... $12,924 $13,515 $12,930 ======= ======= =======
4. OTHER INVESTMENTS Other investments represents equity investments in, and loans to, reinsurance- related enterprises, ceding companies or distribution channels that are expected to generate or secure additional profitable business for the Company. The loans bear interest at rates between 6% and 9% and are repayable between one and five years. Impairment reserves were provided against loans of $3.4 million advanced to COMED in 1999, under a $12 million loan commitment. The COMED loans were settled as part of the divestiture of the health care division.
AS OF DECEMBER 31, ------------------- 2000 1999 -------- -------- U.S. DOLLARS IN THOUSANDS Equity investments........................................ $10,736 $ 4,316 Loans..................................................... 7,000 11,216 ------- ------- 17,736 15,532 Allowance for uncollectible loans......................... -- 3,416 ------- ------- $17,736 $12,116 ======= =======
5. MANAGEMENT FEES RECEIVABLE Management fees receivable represents management fee and related revenues that are primarily due from co-reinsurers and quota share retrocessionnaires to whom a portion of the Company's gross 41 ESG RE LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE THREE YEARS ENDED DECEMBER 31, 2000, 1999, 1998 managed premium is allocated. Management fees receivable at December 31, 2000, and 1999 consist of the following:
AS OF DECEMBER 31, ------------------- 2000 1999 -------- -------- U.S. DOLLARS IN THOUSANDS Fees from co-reinsurers..................................... $582 $ 935 Management fees on 1997 and prior reinsurance pools......... -- 241 Other fees.................................................. 131 127 ---- ------ Total....................................................... $713 $1,303 ==== ======
6. DEFERRED ACQUISITION COSTS Activity in deferred acquisition costs for the years ended December 31, 2000, and 1999 is summarized as follows:
YEARS ENDED DECEMBER 31, ------------------- 2000 1999 -------- -------- U.S. DOLLARS IN THOUSANDS Balance at January 1.................................... $ 57,807 $ 37,625 Acquisition costs incurred.............................. 67,370 86,478 Amortization of acquisition costs....................... (78,566) (66,296) -------- -------- Net change in deferred acquisition costs................ (11,196) 20,182 -------- -------- Balance at December 31.................................. $ 46,611 $ 57,807 ======== ========
42 ESG RE LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE THREE YEARS ENDED DECEMBER 31, 2000, 1999, 1998 7. LOSSES AND LOSS EXPENSES Activity in the reserve for unpaid losses and loss expenses for the years ended December 31, 2000 and 1999 is summarized as follows:
YEARS ENDED DECEMBER 31, ------------------- 2000 1999 -------- -------- U.S. DOLLARS IN THOUSANDS Balance at January 1.................................... $136,935 $ 44,379 Less reinsurance recoverable............................ (11,462) (2,761) -------- -------- Net balance at January 1................................ 125,473 41,618 Incurred related to: Current year.......................................... 75,159 189,489 Prior year............................................ 112,082 9,542 -------- -------- Total incurred losses and loss expenses................. 187,241 199,031 -------- -------- Paid related to: Current year.......................................... 15,901 84,393 Prior year............................................ 132,832 30,783 -------- -------- Total paid losses and loss expenses..................... 148,733 115,176 -------- -------- Net balance at December 31.............................. 163,981 125,473 Plus reinsurance recoverable on incurred losses......... 15,633 11,462 -------- -------- Balance at December 31.................................. $179,614 $136,935 ======== ========
8. INCOME TAXES Under current Bermuda law, the Company is not required to pay taxes in Bermuda on either income or capital gains. Provision for income taxes consists of corporate and other applicable income taxes payable in the various jurisdictions in which the Company conducts its business including, but not limited to, Germany, Ireland, Canada and the United Kingdom. The components of income taxes for the years presented are as follows:
YEARS ENDED DECEMBER 31, ------------------------------ 2000 1999 1998 -------- -------- -------- U.S. DOLLARS IN THOUSANDS Current tax expense Bermuda............................................. $ -- $ -- $ -- Foreign............................................. -- (28) 1,435 ----- ---- ------ Total current tax expense............................. -- (28) 1,435 Total deferred tax expense (benefit).................. -- 843 (173) ----- ---- ------ Total income tax expense.............................. $ -- $815 $1,262 ===== ==== ======
43 ESG RE LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE THREE YEARS ENDED DECEMBER 31, 2000, 1999, 1998 The actual income tax expense attributable to income for the three years in the period ended December 31, 2000 is based on the statutory tax rates in the Company's taxable jurisdictions, which range from 0% to approximately 44%.
YEARS ENDED DECEMBER 31, ------------------------------ 2000 1999 1998 -------- -------- -------- U.S. DOLLARS IN THOUSANDS Computed "expected tax expense"....................... $ -- $ -- $ -- Tax effect of foreign taxes........................... -- 815 1,262 ----- ---- ------ Total income tax expense.............................. $ -- $815 $1,262 ===== ==== ======
Deferred income taxes reflect the tax effect of the temporary differences between the value of assets and liabilities for financial statement purposes and such values as measured by the tax laws and regulations. The principal items in the net deferred income tax asset (liability) are as follows:
YEARS ENDED DECEMBER 31, ------------------- 2000 1999 -------- -------- U.S. DOLLARS IN THOUSANDS Deferred tax assets Net operating loss carryforward........................ $ 11,246 $ 6,948 Other assets........................................... 1,105 956 -------- ------- Gross deferred tax assets................................ 12,351 7,904 Less: valuation allowance................................ (11,444) (6,834) -------- ------- Deferred tax assets after valuation allowance............ $ 907 $ 1,070 ======== ======= Deferred tax liabilities Unrealized investment gains............................ (157) (154) Other liabilities...................................... (750) (916) -------- ------- Total deferred tax liabilities........................... $ (907) $(1,070) -------- ------- Net deferred tax asset................................... $ -- $ -- ======== =======
Realization of the deferred tax asset is dependent on generating sufficient taxable income in the future. During 2000, a valuation allowance of $11,444 to reduce the deferred tax asset was recorded in accordance with the provisions of SFAS109. The valuation allowance is necessary because sufficient uncertainty exists regarding the realizability of certain net operating loss carryforwards. The Company has a loss carryforwards of $65.0 million available to offset future foreign taxable income. Such tax loss carryforwards do not have an expiration date. 44 ESG RE LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE THREE YEARS ENDED DECEMBER 31, 2000, 1999, 1998 9. RETROCESSIONS The Company utilizes retrocessional agreements to reduce its exposure to large claims and catastrophic loss occurrences. These agreements provide for recovery from retrocessionaires of a portion of the losses and loss expenses under certain circumstances. They do not discharge the primary liability of the Company. In the event retrocessionaires were unable to meet their obligations under the retrocession agreements, the Company would be liable for such defaulted amounts. The Company believes that it has minimized the credit risk with respect to its reinsurance by monitoring its retrocessionaires and avoiding concentrations with any single company. Losses and loss expenses incurred and earned premiums as reported in the statement of operations are after deduction for retrocessions. Written and earned premiums and losses incurred for the years ended December 31, 2000, 1999 and 1998 are comprised of the following:
YEARS ENDED DECEMBER 31, ------------------------------ 2000 1999 1998 -------- -------- -------- U.S. DOLLARS IN THOUSANDS Premiums written: Assumed..................................... $244,976 $333,000 $199,872 Ceded....................................... (33,090) (19,790) (4,294) -------- -------- -------- Net premiums written.......................... $211,886 $313,210 $195,578 -------- -------- -------- Premiums earned: Assumed..................................... $260,469 $262,451 $100,985 Ceded....................................... (23,849) (13,326) (2,144) -------- -------- -------- Net premiums earned........................... $236,620 $249,125 $ 98,841 -------- -------- -------- Losses and loss expenses: Assumed..................................... $209,224 $211,645 $ 63,728 Ceded....................................... (21,983) (12,614) (2,364) -------- -------- -------- Net losses and loss expenses.................. $187,241 $199,031 $ 61,364 ======== ======== ========
45 ESG RE LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE THREE YEARS ENDED DECEMBER 31, 2000, 1999, 1998 10. EARNINGS PER SHARE RECONCILIATION OF NUMERATORS AND DENOMINATORS The following is a reconciliation of the numerators and denominators of the basic and diluted earnings per share computations for income from continuing operations:
YEAR ENDED DECEMBER 31, 2000 --------------------------------------- LOSS SHARES PER SHARE (NUMERATOR) (DENOMINATOR) AMOUNT ----------- ------------- --------- U.S. DOLLARS IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA BASIC EARNINGS PER SHARE Net loss allocable to common shareholders................. $(61,796) 11,809,000 $(5.23) Effect of dilutive securities: Class A warrants........................................ -- -- -- Class B warrants........................................ -- -- -- Director and employee options........................... -- -- -- Employee share grant.................................... -- -- -- Repurchase of common shares............................. -- -- -- -------- ---------- ------ DILUTED EARNINGS PER SHARE Net loss allocable to common shareholders................. $(61,796) 11,809,000 $(5.23) ======== ========== ======
YEAR ENDED DECEMBER 31, 1999 --------------------------------------- LOSS SHARES PER SHARE (NUMERATOR) (DENOMINATOR) AMOUNT ----------- ------------- --------- U.S. DOLLARS IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA BASIC EARNINGS PER SHARE Net loss allocable to common shareholders................. $(41,994) 13,260,214 $(3.17) Effect of dilutive securities: Class A warrants........................................ -- -- -- Class B warrants........................................ -- -- -- Director and employee options........................... -- -- -- Employee share grant.................................... -- -- -- Repurchase of common shares............................. -- -- -- -------- ---------- ------ DILUTED EARNINGS PER SHARE Net loss allocable to common shareholders................. $(41,994) 13,260,214 $(3.17) ======== ========== ======
Class A Warrants to purchase 1,381,200 common shares at $20 per share were outstanding as of December 31, 2000 and 1999. Options to purchase up to 1,680,328 common shares, issued at exercise prices between $2.01 and $26.00, were outstanding as of December 31, 2000. Options to purchase up to 1,440,503 common shares, issued at exercise prices between $5.44 and $26.50, were outstanding as of December 31, 1999. The incremental shares from assumed exercise of options and warrants have not been included in the above computations for 2000 and 1999 as they have an anti-dilutive effect on the net loss per common share. 46 ESG RE LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE THREE YEARS ENDED DECEMBER 31, 2000, 1999, 1998 11. COMMITMENTS AND CONTINGENCIES (A) EMPLOYMENT CONTRACTS The Company has entered into various employment contracts with terms of up to three years that have total minimum commitments of $3.1 million, excluding any performance bonuses that are determined by the Board of Directors of the Company. The contracts include various non-compete clauses following termination of employment. As of December 31, 1999, the minimum employee commitments were $7.9 million. (B) LEASE COMMITMENTS The Company and its subsidiaries have various lease obligations. Rental expenses are amortized on the straight-line basis over the term of the lease. Total rental expense was approximately $1,454 thousand, $931 thousand, and $398 thousand for the years ended December 31, 2000, 1999, and 1998, respectively. The Company has leased premises in Germany, Ireland, United Kingdom, Portugal, Hong Kong, Australia, Taiwan, Thailand, Singapore, United States and Canada. The future minimum commitments under operating leases and employment contracts are as follows:
YEAR ENDED DECEMBER 31, 2000 ------------------------------------ LEASE EMPLOYMENT COMMITMENTS COMMITMENTS TOTAL ----------- ----------- -------- U.S. DOLLARS IN THOUSANDS 2001........................................ $ 987 $2,095 $3,082 2002........................................ 845 897 1,742 2003........................................ 755 117 872 2004........................................ 558 -- 558 2005........................................ 353 -- 353 Over five years............................. 654 -- 654 ------ ------ ------ Total....................................... $4,152 $3,109 $7,261 ====== ====== ======
(C) LETTERS OF CREDIT As of December 31, 2000, Secured Letters of Credit and Trust Accounts in the aggregate amount of $95.8 million have been issued in favor of ceding companies with $73.4 million related to Letters of Credit issued and $22.4 million related to Trust Accounts in force. The Letters of Credit and Trust Accounts are secured by a lien on the Company's fixed maturities investment portfolio, equal to 110% of the amount of the outstanding letters of credit, and 102% of the amount of the outstanding Trust Accounts. As of December 31, 1999 Secured Letters of Credit in the amount of $39.1 million were issued in favor of ceding companies. (D) PENSION OBLIGATIONS Certain subsidiaries of the Company are obligated to make defined contributions to pension plans for their employees. As of December 31, 2000 and 1999, there were outstanding liabilities for pension contributions of $568 thousand and $448 thousand respectively. Pension contribution expenses were $732 thousand, $590 thousand, and $143 thousand, for the years ended December 31, 2000, 1999, and 1998, respectively. 47 ESG RE LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE THREE YEARS ENDED DECEMBER 31, 2000, 1999, 1998 (E) DISCONTINUED OPERATIONS On August 10, 2000, the Board of Directors approved a plan for the divestiture of its Health Care Division. Implementation of that plan resulted in the divestiture of 4Sigma (formerly VVB Bermuda Limited) effective June 30, 2000, to affiliates of the Chief Executive Officer and senior management of the Health Care Division. The investors in 4Sigma include the Company, affiliates of the Chief Executive Officer of the Company ("CEO"), Dr. Gerald Moeller, previously a member of the board of ESG Re Limited and Chief Executive--Healthcare Division and former management of the Health Care Division. Terms comparable to those offered to the affiliates of the CEO were offered to non-related parties. The Company owns 8,000,000 convertible preference shares in 4Sigma. The book value of $8.0 million for the Company's equity position is included in other investments. The operations of 4Sigma have entered into a strategic partnership with Bertelsmann/Springer for the marketing of its services to German health insurers. Currently, sales proposals have been made to three of the largest insurers with decisions due in April and May 2001. The expectation is that the group will be successful on at least one of the proposals. In the event none of the proposals are accepted, then the group will be in a position to revisit its business model and the Company would revalue its investment in 4Sigma. Condensed summary operating results for the Health Care Division were as follows:
2000 1999 ---------- ---------- U.S. DOLLARS, IN THOUSANDS Revenues................................................ $ 343 $ 300 Expenses................................................ 5,328 11,924 ------- -------- Net (loss) income....................................... $(4,985) $(11,624) ======= ========
Additionally on August 10, 2000 the Board of Directors approved a plan to liquidate its majority-owned subsidiary in Indonesia. The Company does not expect to recover any debt or equity contributions advanced to and, expensed by, this subsidiary in previous periods. This operation reported a net loss of $1.1 million on revenues of $.6 million in 1999 and a net loss of $.2 million on revenues of $.4 million in 2000. (F) CONTINGENCIES ESG Re and its subsidiaries, in common with the insurance industry in general, are subject to litigation, including claims for punitive damages, in the normal course of their business. ESG Re does not believe that such litigation will have a material adverse effect on its financial condition, future operating results or liquidity. In February 2000, Odyssey Re instituted an action in England against a broker, Stirling Cooke Brown, alleging fraud and conspiracy on the reinsurance placement of 1997 and 1998 Personal Accident and Workers Compensation "carve out" business with Odyssey Re. These proceedings mirror earlier proceedings commenced in New York which were dismissed on jurisdictional grounds. During 1998, ESG accepted a 25% quota share reinsurance treaty with Odyssey Re (UK) retroactive to January 1, 1998. This treaty covers various insurance companies involved in the litigation Odyssey Re instituted in New York over 1997 and 1998 business. This treaty terminated as of December 31, 1998 but ESG renewed its participation for 1999 directly to one of those ceding companies. In December 1999, the Company gave notice to rescind its contract with Odyssey Re (UK) for misrepresentation and failure to disclose material facts. On November 29, 2000 the Company filed suit in the High Court to seek a 48 ESG RE LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE THREE YEARS ENDED DECEMBER 31, 2000, 1999, 1998 judicial confirmation of its rescission. On February 5, 2001, Odyssey Re filed a response. On March 21, 2001, the Company filed a motion for summary judgment. The Company has also given notice to rescind the 1999 account. At this time, the Company is unable to determine the amount of its exposure and the possible effect upon the Company's business, financial condition or results of operation from these two contracts. 12. FIDUCIARY ASSETS AND LIABILITIES As part of its prior underwriting pool management services, the Company collects premiums and pays claims on behalf of the pool participants. In addition to fees received for the underwriting services, the Company also earns interest income on funds it is authorized to hold in accordance with the underwriting management agreements between the Company and the pool participants. The Company is authorized to retain 25% of gross premiums as a claims fund held in bank accounts having trustee status. 13. WARRANTS In connection with the Direct Sales, the Company issued Class A Warrants to purchase up to 1,381,200 common shares and Class B Warrants to purchase up to 1,381,200 common shares if certain performance criteria are satisfied. The Class A Warrants are vested and are exercisable at $20 per share at any time prior to December 2007. Twenty percent of the Class B Warrants are available for vesting during each of the first five years following the closing date of the IPO, and will vest only if, for any 20 consecutive trading days during the one-year vesting period, the percentage change in the market price of the common shares since the closing date of the IPO exceeds the percentage change in the Wilshire 5000 Stock Price Index by at least 500 basis points. The Class B Warrants are exercisable for a period of 10 years from the date of vesting. The exercise price per Common Share is $20 and will be reduced by $1.50 on September 1, 2001. As of December 31, 2000 and 1999, 276,240 of the Class B Warrants are vested and are exercisable. 14. STOCK-BASED COMPENSATION (A) EMPLOYEE STOCK OPTION PLAN The Company has adopted the 1997 Employees Stock Option Plan (the "Stock Option Plan") under which employees of the Company and its subsidiaries are eligible to participate. The Stock Option Plan is administered by the Compensation Committee of the Board. Subject to the provisions of the Stock Option Plan, the Board of Directors has sole discretionary authority to interpret the Stock Option Plan and to determine the terms and conditions of the awards. The exercise price of the option are determined by the Board of Directors when the options are granted. Options granted under the Stock Option Plan are freely assignable subject to certain limitations. The Company has reserved 2,000,000 common shares for issuance under the Stock Option Plan. As of December 31, 2000, options to purchase a total of 1,057,900 shares of common stock were granted, net of forfeitures, to officers and employees of the Company (1999:980,075). Options granted under the Employee Stock Option Plan generally vest at 25% at the date of grant and at 25% on each of the second, third and fourth anniversaries of the date of grant. All options are exercisable at the fair market value of the stock at the date of the grant and expire 10 years after the date of the grant. 49 ESG RE LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE THREE YEARS ENDED DECEMBER 31, 2000, 1999, 1998 (B) DIRECTORS' STOCK OPTION PLAN The Company has adopted the ESG Re Limited Non-management Directors' Compensation and Option Plan (the "Directors' Plan"), under which non-management directors are compensated for their service on the Board. Each non-management director receives fees for services as a member of the Board of Directors and its committees, in amounts determined by the Board of Directors, to be paid in a combination of cash and common shares, as determined by the Board. A Director may elect to receive all or a portion of such fees in the form of options to purchase common shares equal to two times the fees that would otherwise be payable. A director may also elect to defer receipt of the fees, and if so deferred, will receive deferred compensation indexed to the greater of (i) the total return on the common shares; or (ii) the one-year U.S. Treasury bill rate. If a director does not elect the payment in options or deferred compensation alternatives, the fees will be paid in a combination of cash and shares as determined by the Board. Shares granted under the Directors' Plan will not be transferable for six months after receipt. The Company has reserved 1,000,000 common shares for issuance under the Directors' Plan. To date all non-management directors have elected to receive their fees as options to purchase shares. As a result, a total of 622,428 shares of common stock have been granted, net of forfeitures, as stock options as of December 31, 2000 (1999: 460,428). Compensation expense related to these grants of $173 thousand and $232 thousand was recognized for the years ending December 31, 2000 and 1999, respectively. Options granted under the Directors' Plan vest 100% at the date of grant. All options are exercisable at fair market value of the stock at the date of grant and expire 10 years after the date of grant. A summary of the status of the Company's outstanding stock options as of December 31, 2000, 1999 and 1998 is presented below:
2000 1999 1998 -------------------------- -------------------------- ------------------------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE SHARES EXERCISE PRICE SHARES EXERCISE PRICE SHARES EXERCISE PRICE --------- -------------- --------- -------------- -------- -------------- U.S. DOLLARS IN THOUSANDS Outstanding at January 1........ 1,440,503 $15.20 815,428 $21.90 469,714 $20.00 Granted....................... 858,700 $ 5.07 1,033,500 $11.68 355,214 $24.50 Exercised..................... -- -- -- -- -- -- Forfeited..................... (618,875) $17.08 (408,425) $19.66 (9,500) $25.13 --------- ------ --------- ------ ------- ------ Outstanding at December 31...... 1,680,328 $ 9.33 1,440,503 $15.20 815,428 $21.90 --------- ------ --------- ------ ------- ------ Options exercisable at December 31................... 1,302,076 $ 9.89 1,005,378 $13.54 358,678 $22.37 --------- ------ --------- ------ ------- ------ Average fair value of options granted during the year....... $ 2.95 $ 0.88 $ 6.73 ====== ====== ======
The fair value of each option grant was estimated using the Black/Scholes option pricing model with the following assumptions: (i) dividend yield of 8.0%; (ii) expected volatility of 65.6%; (iii) risk-free rate of 6.3%; and (iv) expected life of 8 years. The Company applies APB Opinion 25 and Related Interpretations in accounting for stock based compensation. Had the compensation expense for the Company's stock-based compensation plans been 50 ESG RE LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE THREE YEARS ENDED DECEMBER 31, 2000, 1999, 1998 determined based on the fair value at the grant dates for awards under those plans consistent with the method described in SFAS No. 123, the Company's net loss and earnings per share would have been adjusted to the proforma amounts indicated below:
YEARS ENDED DECEMBER 31, ------------------------------------ 2000 1999 1998 -------- -------- -------- U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA Net (loss) income As reported................................. $(61,796) $(41,994) $14,522 Pro forma................................... (63,224) (42,311) 12,526 -------- -------- ------- Net (loss) income per share As reported................................. $ (5.23) $ (3.17) $ 1.04 Pro forma................................... $ (5.35) (3.19) 0.90 ======== ======== =======
The weighted average remaining contractual life of options outstanding at December 31, 2000, is presented below:
WEIGHTED AVERAGE NUMBER OF OPTIONS NUMBER OF OPTIONS REMAINING RANGE OUTSTANDING EXERCISABLE CONTRACTUAL LIFE ----- ----------------- ----------------- ---------------- $2.01......................................... 10,000 2,500 9.9 years $3.90 - $4.31................................. 326,000 321,500 5.3 $5.44 - $7.75................................. 885,550 567,773 8.7 $8.85......................................... 3,000 3,000 0.4 $14.89........................................ 4,000 2,000 7.8 $16.30 - $18.20............................... 190,350 162,625 7.6 $19.38 - $20.25............................... 122,214 116,464 6.3 $21.62 - $22.88............................... 9,500 5,750 6.0 $25.50 - $26.00............................... 129,714 120,464 7.2
(C) RESTRICTED STOCK AWARD PLAN On February 25, 2000, a restricted stock plan "2000 Restricted Stock Plan" was approved by the Board of Directors. The purpose of the Plan is to provide an incentive to the officers and certain other key employees of the Company and its affiliates (as determined by the Compensation Committee of the Board of Directors) to contribute to the Company's future success and prosperity by making available to them an opportunity to acquire a proprietary interest or to increase their proprietary interest in the Company and to enhance the ability of the Company and its affiliates to attract and retain qualified individuals upon whom, in large measure, the progress, growth, and profitability of the Company depend. The Compensation Committee has discretionary authority to interpret the 2000 Restricted Stock Plan and to determine the terms of any awards, when, if and to whom awards are granted, and 51 ESG RE LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE THREE YEARS ENDED DECEMBER 31, 2000, 1999, 1998 the number of Common Shares covered by each award. An S-8 Registration Statement was filed and effective on March 13, 2000 covering this Plan.
RESTRICTED STOCK AWARDS 2000 ----------------------- --------- Shares Outstanding at January 1............................. 0 Total Shares Granted........................................ 616,400 Shares Forfeited............................................ 50,500 Shares Released upon Vesting................................ 145,450 Shares Outstanding & Subject to Forfeiture.................. 420,450 Shares Remaining available for Grant........................ 1,434,100
15. RELATED PARTIES In 1997, the Company entered into an agreement with Head Asset Management L.L.C. ("Head Asset Management"), an affiliate of Head & Company L.L.C. ("Head Company"), relating to the provision of investment management services. The Chairman of the Board of Directors and Chief Executive Officer is a Managing Member of Head Company. Pursuant to this agreement, which was revised July 1, 2000, and which is subject to the Company's investment guidelines and other restrictions, the Company will pay Head Asset Management a fee equal to the sum of (i) 0.20% per annum of the first $150 million of assets under management, and (ii) 0.15% per annum of assets under management in excess of $150 million. The Company incurred expenses of $397 thousand and $495 thousand under this agreement for the years ended December 31, 2000 and 1999 respectively. 16. SEGMENT INFORMATION SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," requires that an enterprise disclose information about its operating segments. The Company considers its reinsurance activities to constitute a single operating segment on the basis that such activities are monitored and evaluated primarily on a company wide basis. Investments are held in support of reinsurance activities and are considered to be a part of the reinsurance segment 52 ESG RE LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE THREE YEARS ENDED DECEMBER 31, 2000, 1999, 1998 The following table provides summary financial information by the Company's lines of business and geographic regions of the reinsurance segment. Revenues are allocated geographically on the basis of the location of the legal entity that retains the reinsurance risk.
YEAR ENDED DECEMBER 31, 2000 ----------------------------------------------------------------- MEDICAL ACCIDENT CREDIT LIFE OTHER TOTAL --------- -------- -------- -------- -------- --------- U.S. DOLLARS IN THOUSANDS Gross premiums written................... $ 173,919 $ 54,140 $ 3,405 $ 8,977 $ 4,535 $ 244,976 Net premiums written..................... 148,285 49,029 3,162 7,845 3,565 211,886 Net premiums earned...................... 161,772 57,620 6,588 6,127 4,514 236,620 Losses and loss expenses................. (124,119) (52,406) (2,344) (5,291) (3,081) 187,241 Acquisition costs........................ (53,471) (17,840) (3,527) (1,622) (2,106) (78,566) Operating costs.......................... (24,628) (9,677) (844) (1,044) (927) (37,120) --------- -------- ------- ------- -------- --------- Net underwriting income (loss)........... $ (40,446) $(22,303) $ (127) $(1,830) $ (1,600) $ (66,306) ========= ======== ======= ======= ======== =========
YEAR ENDED DECEMBER 31, 1999 ----------------------------------------------------------------- MEDICAL ACCIDENT CREDIT LIFE OTHER TOTAL --------- -------- -------- -------- -------- --------- U.S. DOLLARS IN THOUSANDS Gross premiums written................... $ 251,984 $ 66,514 $ 1,851 $ 6,934 $ 5,717 $ 333,000 Net premiums written..................... 240,314 61,549 714 5,550 5,083 313,210 Net premiums earned...................... 188,016 42,443 3,933 9,593 5,140 249,125 Losses and loss expenses................. (153,894) (33,001) (2,424) (8,015) (1,697) (199,031) Acquisition costs........................ (52,940) (9,287) (795) (1,516) (1,758) (66,296) Operating costs.......................... (16,503) (4,393) (421) (976) (550) (22,843) --------- -------- ------- ------- -------- --------- Net underwriting income (loss)........... $ (35,321) $ (4,238) $ 293 $ (914) $ 1,135 $ (39,045) ========= ======== ======= ======= ======== =========
YEARS ENDED DECEMBER 31, ------------------------------ 2000 1999 1998 -------- -------- -------- U.S. DOLLARS IN THOUSANDS REVENUE EARNED: Bermuda....................................... $ 68,569 $ 75,666 $ 43,839 Ireland....................................... 166,422 173,860 59,281 Germany....................................... 12,678 12,097 8,812 Other......................................... 1,363 966 3,895 -------- -------- -------- Total revenues................................ $249,032 $262,589 $115,827 ======== ======== ========
17. SIGNIFICANT CLIENTS For the year ended December 31, 2000, no client contributed more than 10% of total revenue. For the year ended December 31, 1999, one significant client relationship contributed $64.1 million to total revenue. For the year ended December 31,1998, one significant client contributed $25.1 million to total revenue. 53 ESG RE LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE THREE YEARS ENDED DECEMBER 31, 2000, 1999, 1998 18. STATUTORY REQUIREMENTS AND DIVIDEND RESTRICTIONS Under Bermuda law, the Company is prohibited from declaring or paying a dividend if such payment would reduce the realizable value of its assets to an amount less than the aggregate value of its liabilities, issued share capital (common share capital) and share premium (additional paid-in capital) accounts. Under the Bermuda Insurance Act, 1978, amendments thereto and Related Regulations, ES Bermuda is required to maintain certain measures of solvency and liquidity. For the years ended December 31, 2000 and 1999, these requirements have been met. The statutory capital and surplus of ES Bermuda was $76.6 million and $131.0 million and the minimum required statutory capital and surplus was $8.5 million and $13.2 million as of December 31, 2000 and 1999, respectively. The minimum required level of liquid assets was $80.1 million and $81.4 million with actual liquid assets of $143.7 million and $138.5 million as of December 31, 2000 and 1999, respectively. 54 ESG RE LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE THREE YEARS ENDED DECEMBER 31, 2000, 1999, 1998 19. UNAUDITED QUARTERLY FINANCIAL DATA
FIRST SECOND THIRD FOURTH 2000 OPERATING DATA QUARTER QUARTER QUARTER QUARTER ------------------- -------- -------- -------- -------- U.S. DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA Net Premiums written.................................. $104,479 $44,675 $ 16,010 $ 46,722 Net Premiums earned................................... 57,811 76,446 39,756 62,607 Management fee revenue................................ 362 594 224 667 Net investment income................................. 2,926 3,165 3,600 3,233 Losses and loss expenses.............................. 45,229 54,689 44,477 42,846 Acquisition costs..................................... 14,679 23,444 18,264 22,179 Underwriting profit (loss)............................ (2,097) (1,687) (22,985) (2,417) Income (loss) from continuing operations.............. (7,306) (6,313) (35,048) (7,951) Income (loss) from discontinued operations............ (2,920) (3,008) 750 -- Net income (loss)..................................... (10,226) (9,321) (34,298) (7,951) Earnings per common share: Basic/Diluted net income (loss) from continuing operations per share.............................. $ (0.63) $ (0.53) $ (2.97) $ (0.67) Basic/Diluted net income (loss)..................... (0.88) (0.79) (2.90) (0.67) Weighted average shares outstanding (000's): Basic............................................. 11,576 11,837 11,817 11,822 Diluted........................................... 11,576 11,837 11,817 11,822 FIRST SECOND THIRD FOURTH 1999 OPERATING DATA QUARTER QUARTER QUARTER QUARTER ------------------- -------- -------- -------- -------- U.S. DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA Net Premiums written.................................. $143,566 $40,304 $ 59,748 $ 69,592 Net Premiums earned................................... 58,124 67,522 67,455 56,024 Management fee revenue................................ 817 874 (252) 689 Net investment income................................. 3,300 3,705 3,478 3,032 Losses and loss expenses.............................. 34,751 48,909 56,637 58,734 Acquisition costs..................................... 18,810 14,108 19,761 13,617 Underwriting profit (loss)............................ 4,563 4,505 (8,943) (16,327) Income (loss) from continuing operations.............. 3,991 3,206 (14,160) (22,259) Income (loss) from discontinued operations............ -- 266 (9,000) (4,038) Net income (loss)..................................... 3,991 3,472 (23,160) (26,297) Earnings per common share: Basic/Diluted net income (loss) from continuing operations........................................ $ 0.29 $ 0.23 $ (1.03) $ (1.72) Basic/Diluted net income (loss)..................... 0.29 0.25 (1.68) (2.04) Weighted average shares outstanding (000's): Basic............................................. 13,924 13,923 13,792 12,907 Diluted........................................... 13,934 13,924 13,792 12,907
55 ESG RE LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) FOR THE THREE YEARS ENDED DECEMBER 31, 2000, 1999, 1998
FIRST SECOND THIRD FOURTH 1998 OPERATING DATA QUARTER QUARTER QUARTER QUARTER ------------------- -------- -------- -------- -------- U.S. DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA Net Premiums written.................................... $84,156 $19,526 $53,915 $37,981 Net Premiums earned..................................... 23,219 18,090 26,134 31,398 Management fee revenue.................................. 970 229 181 514 Net investment income................................... 3,020 3,211 3,359 3,340 Losses and loss expenses................................ 15,642 11,340 15,940 18,442 Acquisition costs....................................... 5,270 4,434 7,324 9,686 Underwriting profit..................................... 2,307 2,316 2,870 3,270 Net income.............................................. 3,251 3,247 3,994 4,030 Earnings per common share: Basic net income per share............................ $ 0.23 $ 0.23 $ 0.29 $ 0.29 Diluted net income per share.......................... 0.23 0.23 0.29 0.29 Weighted average shares outstanding (000's): Basic............................................... 13,924 13,924 13,924 13,924 Diluted............................................. 14,374 14,231 13,925 13,926
56 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III. ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY EXECUTIVE OFFICERS The table below sets forth the names, ages and titles of the persons who are executive officers of the Company and/or its principal operating subsidiaries as of March 15, 2001.
NAME AGE POSITION ---- -------- ---------------------------------- John C Head III................... 52 Chairman and Chief Executive Officer Steven H Debrovner................ 63 Director Alasdair P Davis.................. 48 Chief Operating Officer Mark E Oleksik.................... 48 Senior Financial Officer and Controller Margaret L Webster................ 50 Chief Administrative Officer and Corporate Secretary
John C Head III has served as Chairman of the Board since the inception of the Company and is a member of the Compensation Committee. He was appointed Chief Executive Officer of the Company in September 1999 and will retire as CEO at the 2001 Annual General Meeting. Mr. Head has been a Managing Member of Head & Company L.L.C., an investment banking firm specializing in the insurance industry, since 1987. Mr. Head is also a director of FFTW, Inc. and other private companies. Steven H. Debrovner has served as a director of the Company since February 1998. He served as the Chief Operating Officer from the inception of the Company until November 1998, Chief Executive--Reinsurance from November 1998 until December 2000 and is currently serving as a Director. Mr. Debrovner co-founded ESG Germany in 1993. Alasdair P. Davis was appointed to the Board on February 1, 2001. He will be elected Chief Executive Officer effective May 8, 2001. He joined the Company as Chief Underwriting Officer in January 2000 and was elected Chief Operating Officer in November 2000. Mr. Davis was an underwriter with LDG Worldwide from 1996 until 2000. Mark E. Oleksik joined ESG Re Limited in November, 2000 and currently serves as Senior Financial Officer and Controller. He is responsible for the financial affairs of the company. Prior to joining ESG, he served as Director of Group Services for Uniprise, a subsidiary of United Health Group, from November, 1998 to November, 2000. From March, 1995 to October, 1997 he was Senior VP and Regional Director for Alexsis Inc., a third party administrator and subsidiary of CNA Financial Corporation. From July, 1972 to March, 1995 he served in various capacities with Alexander & Alexander Services Inc., an international insurance broking and consulting firm, including Finance Director for its retail broking operations and corporate controller and chief accounting officer for its worldwide operations. Margaret L. Webster has been Chief Administrative Officer since March 1999. From November 1997 to March 1999, Ms. Webster was V.P. Systems of Lincoln National Life Insurance in Ft. Wayne, Indiana. Between 1995 and 1997, she was V.P. Systems of TIG Insurance Company in Dallas, Texas. Prior to that, Ms. Webster served in various positions, such as Attorney, V.P. of Human Resources, V.P. of Quality and Professional Standards at Alexander & Alexander in Baltimore, Maryland. 57 On May 15, 2000, Joan Dillard left the Company to pursue an opportunity with a US based company. Ms Dillard had served as Chief Financial Officer of the Company since March 1998. Najib Nathoo assumed the role of Senior Financial Officer upon Ms Dillard's departure and filled that role until December 31, 2000. Mr Nathoo returned to NLN Associates, a privately held consultancy concern with which he had been previously associated. Mr Oleksik took over the role of Senior Financial Officer on January 1, 2001. The information with respect to directors of the Company is contained under the captions "Election of Directors" in the Proxy Statement and is incorporated herein by reference in response to this item. The information required in this item with respect to Section 16(a) compliance disclosure is incorporated by reference from the Company's definitive Proxy Statement for its 2001 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission pursuant to Regulation 14A under the Securities Exchange Act of 1934. ITEM 11. EXECUTIVE COMPENSATION The Information with respect to executive compensation is contained under the caption "Executive Compensation" in the Proxy Statement and is incorporated herein by reference in response to this item. On February 25, 2000, a restricted stock plan "2000 Restricted Stock Plan" was approved by the Board of Directors. The purpose of the Plan is to provide an incentive to the officers and certain other key employees of the Company and its affiliates (as determined by the Compensation Committee of the Board of Directors) to contribute to the Company's future success and prosperity by making available to them an opportunity to acquire a proprietary interest or to increase their proprietary interest in the Company and to enhance the ability of the Company and its affiliates to attract and retain qualified individuals upon whom, in large measure, the progress, growth, and profitability of the Company depend. The Compensation Committee has discretionary authority to interpret the 2000 Restricted Stock Plan and to determine the terms of any awards, when, if and to whom awards are granted, and the number of Common Shares covered by each award. An S-8 Registration Statement was filed and effective on March 13, 2000 covering this Plan. The Board of Directors made grants to 25 employees of the Company on March 14, 2000, totaling 616,400 shares. The shares will vest as follows, assuming the employee remains in the employ of the Company until the vest date: 25% on September 14, 2000; 25% on September 14, 2001; 25% on September 14, 2002; and 25% on September 14, 2003. Mr. Head was awarded 350,000 shares pursuant to the terms of his employment agreement. Mr. Debrovner was awarded 41,200 shares. Ms. Webster was awarded 25,000 shares. Mr Davis was awarded 12,000 shares. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information with respect to security ownership of certain beneficial owners and management is contained under the caption "Information Regarding the Security Ownership of Certain Beneficial Owners, Management and Directors" in the Proxy Statement and is incorporated herein by reference in response to this item. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information with respect to certain relationships and related transactions is contained under the caption "Certain Relationships and Related Transactions" in the Proxy Statement and is incorporated herein by reference in response to this item. 58 PART IV. ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES AND REPORTS ON FORM 8-K (a) 1. FINANCIAL STATEMENTS: 3. EXHIBITS: 2.1* Share Exchange Agreement between ESG Re Limited and European Specialty Group (United Kingdom) Limited, dated as of November 13, 1997 2.2* Share Exchange Agreement between the shareholders of European Specialty Group Holding AG and European Specialty Group (United Kingdom) Limited, dated as of November 13, 1997 3.1* Memorandum of Association 3.2* Bye-Laws 4.1* Specimen Common Share certificate 4.2* Form of Class A Warrant 4.3* Form of Class B Warrant 10.1* Form of Subscription Agreement, between ESG Re Limited and certain Direct Purchasers, dated as of September 30, 1997 10.2* Employment Agreement between European Specialty Group (United Kingdom) Limited, ESG Re Limited and Wolfgang M. Wand, dated as of December 1, 1997 10.3* Employment Agreement between ESG Re Limited and Steven H. Debrovner, dated as of December 1, 1997 10.4**** Employment Agreement between ESG Re Limited and John C Head III, dated as of September 1, 1999 10.5**** Employment Agreement between ESG Re Limited and Joan H. Dillard, dated as of March 23, 1998 10.6**** Employment Agreement between ESG Re Limited and Margaret L. Webster, dated as of March 1, 1999 10.7* Employment Agreement between European Specialty (North America) Limited and Renate M. Nellich, dated as of December 1, 1997 10.8* Investment Advisory Agreement between ESG Re Limited and Head Asset Management L.L.C., dated as of December 1, 1997 10.9* Investment Advisory Agreement between European Specialty Ruckversicherung AG and Head Asset Management L.L.C., dated as of December 1, 1997 10.10* Form of Registration Rights Agreement between ESG Re Limited and the Direct Purchasers named therein 10.11** Form of Non-Management Directors' Compensation and Option Plan, approved on December 3, 1997 between ESG Re Limited and non-employee director optionees 10.12** Form of 1997 Stock Option Plan, approved on December 3, 1997 between ESG Re Limited and certain optionees 10.13*** Form of 2000 Restricted Stock Plan, approved on February 25, 2000 between ESG Re Limited and certain recipients 10.14 Employment Agreement between ESG Re Limited and Alasdair Davis, dated as of January 17, 2000.
59 10.15 Employment Agreement between ESG Re Limited and John C Head III dated as of January 1, 2001. 21* Subsidiaries of the Registrant
------------------------ * Incorporated by reference to Amendment No. 1 to the Registration Statement on Form F-1 of the Company, as filed with the Securities and Exchange Commission on December 9, 1997 (registration No. 333-40341). The Consent by the Company's independent auditors to incorporate by reference is set forth in Exhibit 24.1(b) of this report. ** Incorporated by reference to Exhibit 10.9 of the Company's Form 10-K for the year ended December 31, 1997, filed with the Securities and Exchange Commission on March 31, 1998. *** Incorporated by reference to the Registration Statement on Form S-8 of the Company, as filed with the Securities and Exchange Commission on March 13, 2000 (registration No. 333-32302). **** Incorporated by reference to Exhibit 10.4, 10.5 and 10.6, respectively, of the Company's Form 10-K/A for the year ended December 31, 1999, filed with the Securities and Exchange Commission on April 19, 2000. (b) Reports on Form 8-K. The Company filed reports on Form 8-K on January 4, 2000, March 14, 2000, April 18, 2000, September 7, 2000, December 18, 2000 and December 27, 2000. There were no other reports on Form 8-K filed during the period from January 1, 2000, to December 31, 2000. 60 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, thereunto authorized on April 2, 2001. ESG RE LIMITED By: /s/ MARK E OLEKSIK ----------------------------------------- Name: Mark E Oleksik Title: SENIOR FINANCIAL OFFICER AND CONTROLLER
Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
SIGNATURE TITLE DATE --------- ----- ---- /s/ JOHN C HEAD III ------------------------------------------- Chairman of the Board, Chief April 2, 2001 John C Head III Executive Officer and Director /s/ ALASDAIR P DAVIS ------------------------------------------- Chief Operating Officer and April 2, 2001 Alasdair P Davis Director /s/ STEVEN H DEBROVNER ------------------------------------------- Director April 2, 2001 Steven H Debrovner /s/ MARK E OLEKSIK ------------------------------------------- Senior Financial Officer and April 2, 2001 Mark E Oleksik Controller /s/ ISAO KUZUHARA ------------------------------------------- Director April 2, 2001 Isao Kuzuhara /s/ DAVID L NEWKIRK ------------------------------------------- Director April 2, 2001 David L Newkirk /s/ DAVID C WINN ------------------------------------------- Director April 2, 2001 David C Winn
61 ESG RE LIMITED INDEPENDENT AUDITORS' REPORT To the Board of Directors and Shareholders of ESG Re Limited We have audited the accompanying consolidated balance sheets of ESG Re Limited and subsidiaries as of December 31, 2000 and 1999, and the related consolidated statements of operations, changes in shareholders' equity, cash flows and comprehensive income for each of the three years in the period ended December 31, 2000. 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 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 audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company and its subsidiaries as of December 31, 2000 and 1999, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States of America. DELOITTE & TOUCHE Chartered Accountants Dublin, Ireland April 2, 2001 62