ITEM 1 - -BUSINESS
THE COMPANY
Stirling Cooke Brown Holdings Limited (the "Company") is a Bermuda holding company incorporated on December 12, 1995, which, through its subsidiaries, provides insurance services and products. The Company provides its range of services and products to insurance and reinsurance companies, insurance agents, and insureds. The Company is involved primarily in the workers' compensation, occupational accident and health, and property/casualty insurance markets through its subsidiaries located in London, Bermuda and the United States.
THE COMPANY'S OPERATIONS
The Company has three main business segments; Insurance, Program Business, and Brokerage. In early 2001, following a review of its operations, the Company decided to discontinue its reinsurance and underwriting management segments. Each business segment consists of one or more separate companies and the results of each segment reflect all fees, income, and direct expenses for the companies in that segment. For example, revenues for the insurance segment include all of the insurance company's income including premiums, policy issuance fees, and investment income.
INSURANCE
The Company's insurance segment consists of a New York-domiciled insurer, Realm National Insurance Company ("Realm National"). Realm National was acquired by the Company in September 1996 and earns net premiums and policy issuance fees. The insurance segment generated revenues of $29.9 million in 2001, $23.5 million in 2000, and $12.6 million in 1999. This increase in revenues reflects a reduced amount of reinsurance purchased. The World Trade Center disaster of September 11, 2001 had an immaterial effect on the results of operations of Realm National for the year ended December 31, 2001.
Realm National had shareholders' equity of approximately $17.8 million at December 31, 2001 (2000--$17.8 million, 1999--$21.8 million), and net premiums earned of approximately $27.8 million for the year ended December 31, 2001 (2000--$18.5 million, 1999--$9.5 million). For the year ended December 31, 2001, Realm National's gross premiums written were $40.0 million (2000--$61.4 million, 1999--$47.2 million); net premiums written were $32.8 million (2000--$22.2 million, 1999--$8.9 million), of which $27.1 million (2000--$16.1 million, 1999--$7.9 million) were related to workers' compensation insurance and $5.7 million (2000--$6.1 million, 1999--$1.0 million) were related to property and casualty insurance. Realm National is rated B+ (Very Good) by A.M. Best Company.
PROGRAM BUSINESS
The Company's program business segment consists of subsidiaries that market insurance products and manage insurance programs developed by the Company. These programs transfer risk from an insured to insurers and ultimately to reinsurers primarily in the workers' compensation market. The segment's subsidiaries are integrated to provide a range of business production and administrative services to insurers. The program business segment services are provided to unaffiliated primary insurers and a Company-owned primary insurer. This segment primarily consists of managing general agency ("MGA"), program management, third party claims administration ("TPA"), and loss control and premium audit companies. The program business segment generated revenues of $11.4 million in 2001, $15.3 million in 2000, and $22.4 million in 1999. This continued decrease in revenues was primarily due to reduced fee margins on programs and a reduction in program business volume as a result of management's decision to impose more selective underwriting conditions on continuing programs.
The Company's MGA subsidiaries are responsible for marketing programs through a network of retail and wholesale insurance agents. The MGA's are also responsible for underwriting, policy issuance, policy servicing, and administration of the business bound. The Company's MGA network includes offices in Boca Raton, Florida and New York, New York. As part of a continuing effort to streamline operations and reduce ongoing costs, the Company consolidated its Dallas, Texas MGA office with its Boca Raton MGA office effective December 31, 2001.
BROKERAGE
The Company's brokerage segment consists of subsidiaries that receive a fee or commission for brokering insurance and reinsurance contracts. These subsidiaries specialize in placing insurance and reinsurance business in workers' compensation, accident and health, and specialty casualty lines. The Company generates fees and commission-based revenues from this business. The brokerage segment generated revenues of $5.8 million in 2001, $11.2 million in 2000 and $24.9 million in 1999. This decrease in brokerage segment revenues was primarily the result of reduced business being brokered due to significantly diminished reinsurance capacity for workers' compensation business. The segment has been adversely affected by the disruption caused by widespread reinsurance market disputes and legal proceedings including those involving the Company.
DISCONTINUED OPERATION
Following a review of its operations, the Company decided on March 6, 2001 to discontinue its reinsurance and underwriting management segments and put these segments into run-off.
The Company's reinsurance segment consists of its reinsurance subsidiary, Comp Indemnity Reinsurance Company Limited ("CIRCL"). CIRCL primarily reinsured workers' compensation and property and general liability risks. Management determined in early 1999 to cease underwriting new programs in the reinsurance segment due to unfavourable results, and for this reason, a number of existing contracts were not renewed for the 1999 year. Due to the history of operating losses in the segment, together with the cessation of the writing of new programs, the Company decided to completely discontinue the segment and place the operation into run-off effective December 31, 2000.
The reinsurance segment generated revenues of ($0.1) million in 2001, $1.7 million in 2000 and $3.1 million in 1999. For the year ended December 31, 2001, CIRCL's gross premiums assumed were $0.3 million (2000--$0.3 million, 1999--$3.0 million), of which $0.2 million (2000--$0.2 million, 1999--$2.7 million) were related to workers' compensation insurance and $0.1 million (2000--$0.1 million, 1999--$0.3 million) were related to property and general liability insurance. Net premiums assumed were ($0.3) million (2000--$0.4 million, 1999--$1.1 million).
The Company's underwriting management segment is comprised of companies that primarily underwrote and administered reinsurance business on behalf of independent reinsurance companies. The underwriting management segment earned fees for providing underwriting and associated administrative services relating to the business underwritten. Since 1999, the underwriting management segment has experienced a significant reduction in business written, which has led to decreasing revenues over the period. In view of the reduction in revenues, the resulting loss, and the ongoing business prospects for the segment, the Company decided to discontinue the segment and place the operation in run-off. The underwriting management segment generated revenues of $0.6 million in 2001, $1.6 million in 2000, and $4.1 million in 1999.
As a result of the planned run-off of operations for the underwriting management and reinsurance segments, the operating results of the underwriting management and reinsurance segments in the accompanying financial statements have been reported as discontinued operations for all periods presented, and, accordingly, the operating results for periods prior to 2000 have been restated.
MARKETING
The Company's marketing strategies vary by business segment. The Company's program business segment markets its workers' compensation programs and other specialty lines to retail and wholesale insurance agents in the U.S. through its MGA's. Individual MGA offices market their services and products through sales representatives, targeted direct mail, local and regional advertising, seminars, and trade and industry conventions. Given a general reliance on retail agents as an important source of business production, special emphasis is placed on building and maintaining relationships with individual retail agents and on expanding its network of retail producers. To encourage loyalty from the retail agents the Company seeks to provide a high level of service, offer insurance products that satisfy the needs of clients and provide certain incentives for the achievement of the Company's objectives. The Company believes that it has successfully developed a reputation for providing quality service, cost-effective products and strong marketing support, which has enabled it to develop strong relationships with its retail agents and commercial customers. The Company's insurance segment markets its insurance products through the Company's own MGA network and to independent insurance agents through unaffiliated agent networks. The Company's brokerage segment markets its services directly to insurance and reinsurance companies, as well as to insurance agents.
COMPETITION
The business of providing insurance services and products to the workers' compensation and property and casualty insurance markets is highly competitive. The Company competes with providers of traditional insurance coverage and with providers of alternative market services (including domestic and foreign insurance companies, reinsurers, insurance brokers, captive insurance companies, rent-a-captives, self-insurance plans, risk retention groups, state funds, assigned risk pools and other risk-financing mechanisms). The Company believes that the key factors in competing effectively in the risk management market are price, the ability to tailor programs to the needs of the insured, and the ability to rapidly develop new solutions to address changing market conditions. The Company believes that its services and products are competitively priced, and that its combination of services and products enables it to develop tailored programs and be a competitive provider of insurance services and products. However, in periods of soft insurance market conditions the Company's various business segments are subject to additional competitive pressure in generating premium volume. In addition, the fees that they charge for their services come under pressure as insurers and reinsurers seek to reduce their costs.
Realm National is rated B+ (Very Good) by A.M. Best Company. In certain circumstances, Realm National may be at a competitive disadvantage to insurers with higher ratings. However, the Company's MGA's also represent insurers with higher ratings from A.M. Best Company, thereby allowing the Company's MGA's to remain competitive in circumstances where Realm National is not selected as the insurer due to its rating.
EMPLOYEES
As of December 31, 2001, the Company had 228 employees. The service nature of the Company's business makes its employees an important corporate asset. While the market for qualified personnel is extremely competitive, the Company believes that its relationships with its employees are good. None of the Company's employees is represented by a union.
REGULATION
The Company's subsidiaries that are engaged in the insurance and discontinued reinsurance segments (Realm National and CIRCL, respectively) are subject to regulation by government agencies in the states and foreign jurisdictions in which they do business. The nature and extent of such regulation vary from jurisdiction to jurisdiction, but typically involve prior approval of the acquisition of control of an insurance company or of any company controlling an insurance company; regulation of certain transactions entered into by an insurance company with any of its affiliates; approval of premium rates and policy forms for many lines of insurance; standards of solvency and minimum amounts of capital and surplus that must be maintained; establishment of reserves required to be maintained for unearned premium, losses and loss expense or for other purposes; limitations on types and amounts of investments; restrictions on the size of risks which may be insured; licensing of insurers and agents; deposits of securities for the benefit of policyholders; and the filing of periodic reports with respect to financial condition and other matters.
Most states require property and casualty insurers licensed to transact insurance in those states to become members of insolvency funds or guaranty associations which generally protect policyholders against the insolvency of such insurers. Members of the fund or association must contribute to the payment of certain claims made against insolvent insurers. Maximum contributions required by law in any one year vary between 1% and 2% of annual premiums written by a member in that state. Assessments from insolvency funds paid by Realm National in 1999, 2000 and 2001 were immaterial in relation to the Company's consolidated financial statements. The cost of some of these assessments is recoverable through future policy surcharges and premium tax deductions.
Realm National also is required to participate in various state-mandated insurance facilities or in funding mandatory pools, which are generally designed to provide insurance coverage for consumers who are unable to obtain insurance in the voluntary insurance market. One such pool is the multi-state workers' compensation pool operated by the National Council on Compensation Insurance. These pools typically require all companies writing applicable lines of insurance in the state for which the pool has been established to fund deficiencies experienced by the pool based upon each company's relative premium writings in that state, with any excess funding typically distributed to the participating companies on the same basis. Total assessments incurred by Realm National from all such facilities for 1999, 2000, and 2001 were immaterial in relation to the Company's consolidated financial statements.
The company is subject to guaranty fund and other assessments by the states in which it writes business. The company has paid $0.66 million and accrued $0.2 million liability for guaranty fund and other assessments. This accrual represents management's best estimates based on information received from the states in which the Company writes business and may change due to many factors including the Company's share of the ultimate cost of current insolvencies.
Realm National also is subject to various statutory and regulatory restrictions, generally applicable to each insurance company in its state of domicile, which limit the amount of dividends or distributions payable by an insurance company to its shareholders. The restrictions are generally based on certain levels of surplus, investment income, and operating income, as determined under statutory accounting practices.
The insurance laws of the State of New York (the "New York Insurance Law") regulate the distribution of dividends and other payments to the Company by Realm National. Under the applicable New York statute, unless prior regulatory approval is obtained, an insurer may not declare or distribute any dividend to shareholders, which, together with all dividends declared or distributed by it during the preceding twelve months, exceeds the lesser of (i) 10% of its surplus to policyholders as shown by its last statement on file with the New York Department of Insurance, or (ii) 100% of adjusted net investment income during such period. Such restrictions or any additional subsequently imposed restrictions may in the future affect the Company's ability to pay principal and interest on its debt, expenses, and cash dividends to its shareholders.
The National Association of Insurance Commissioners ("NAIC") has adopted a methodology for assessing the adequacy of statutory surplus of property and casualty insurers that includes a risk-based capital requirement. Insurance companies are required to calculate and report information under a risk-based formula that attempts to measure statutory capital and surplus needs based on the risks in a company's mix of products and investment portfolio. The formula is designed to allow state insurance regulators to monitor the adequacy of an insurer's capital. Under the formula, a company determines its risk-based capital ("RBC") by taking into account certain risks related to the insurer's assets (including risks related to its investment portfolio and ceded reinsurance) and the insurer's liabilities (including underwriting risks related to the nature and experience of its insurance business). The RBC rules provide for different levels of regulatory attention depending on the ratio of a company's total adjusted capital to its "authorized control level" of RBC. Under the formula, a higher ratio reflects a greater adequacy of capital. Based on calculations made by the Company, the RBC level for the Company's insurance subsidiary exceeds levels that would trigger regulatory attention. At December 31, 2001, Realm National's RBC ratio was approximately 263%, and the threshold requiring minimum regulatory involvement was 175%. Therefore, the Company's capital exceeded all requirements of the Risk-Based Capital Model Act. The NAIC has also developed an Insurance Regulatory Information System ("IRIS") to assist state insurance departments in their oversight of the financial condition of insurance companies operating in their respective states. IRIS identifies 11 industry ratios and specifies "usual values" for each ratio. Departure from the usual values in four or more ratios generally leads to inquiries from individual state insurance commissioners. At December 31, 2001, Realm National had four ratios outside the normal ranges; however, management believes that they will be able to satisfy any concerns raised by the regulators.
Realm National is organized under New York Insurance Law. The New York Insurance Law provides that the acquisition or change of "control" of a domestic insurer, or any person who controls a domestic insurer, cannot be consummated without the prior approval of the relevant insurance regulatory authority. A person seeking to acquire control, directly or indirectly, of a domestic insurance company, or any person controlling a domestic insurance company, must seek approval and generally file with the relevant insurance regulatory authority an application for change of control (commonly known as a "Form A") containing certain information required by statute and published regulations and provide a copy of such Form A to the domestic insurer. Under the New York Insurance Law, control is presumed to exist if any person, directly or indirectly, owns, controls, holds with power to vote or holds proxies representing ten percent or more of the voting securities of any other person.
In addition to the oversight of the Company's insurance subsidiaries, the Company, as the ultimate parent of a New York-domiciled insurer (Realm National), is also subject to regulation under the New York Insurance Holding Company System Regulatory Act (the "Holding Company Act"). The Holding Company Act contains certain reporting requirements including those requiring the Company, as the ultimate parent company, to file information relating to its capital structure, ownership, and financial condition and general business operations of its insurance subsidiaries. The Holding Company Act contains special reporting and prior approval requirements with respect to transactions among affiliates.
In addition, many state insurance regulatory laws contain provisions that require pre-notification to state agencies of a change in control of a non-domestic insurance company admitted in that state. While such pre-notification statutes do not authorize the state agency to disapprove the change of control, such statutes do authorize issuance of a cease and desist order with respect to the non-domestic admitted insurer if certain conditions exist, such as undue market concentration.
The Company intends, when appropriate, to eventually expand Realm National's licenses and business to additional states in which it is not currently licensed. In order to obtain a license in a given state, Realm National must complete an application and demonstrate compliance with state licensing requirements. The applicable insurance regulatory authority reviews the application, which may take from three months to two or more years. If all the requirements are met, a license is issued.
In determining whether to issue a license to do business in a state, the state's insurance regulatory agency is required by statute or regulation to consider a number of factors, largely for the purpose of protecting policyholders within the state. Typically, the application process will involve a review of the applicant's recent audited and statutory financial statements, and, in many states, one or more years of operating projections, to assess the financial strength of the applicant; biographical information concerning the experience and fitness of directors, officers and major shareholders; reports of recent examinations as to the applicant's compliance record, finances and market practices in its state of domicile; proposed policy forms and rate schedules; and the applicant's experience in underwriting the line or lines of business to be offered. During 2001, an examination of the financial statements as of December 31, 2000 was completed, and did not lead to any adjustments. The examination was led by the New York State Department of Insurance.
As a holding company, the Company is not subject to Bermuda insurance regulations. However, the Bermuda Insurance Act 1978, as amended (the "Insurance Act"), which regulates the insurance business of CIRCL, a discontinued reinsurance subsidiary of the Company, provides that no person shall carry on insurance business in or from within Bermuda unless registered as an insurer under the Insurance Act by the Minister of Finance (the "Minister"). The registration of an applicant as an insurer is subject to its compliance with the terms of its registration and such other conditions as the Minister may impose from time to time.
In general, the regulation of insurers in Bermuda relies heavily upon auditors, loss reserve specialists, directors and managers who must certify that an insurer meets minimum capital and solvency requirements. Every registered insurer must appoint a government-approved auditor who will annually audit and report on the Statutory Financial Statements and the Statutory Financial Return of the insurer.
CIRCL is registered as a Class 3 insurer and, as such: (i) is required to maintain a minimum statutory capital and surplus equal to the greatest of: (a) $1 million; (b) 20% of the first $6 million of its net premiums written plus 15% of its net premiums written over $6 million; or (c) 15% of its net outstanding losses and loss expenses; (ii) is limited in declaring or paying any dividends during any financial year with respect to a specified minimum solvency margin or minimum liquidity ratio or if the declaration or payment of such dividends would cause it to fail to meet such margin or ratio; (iii) is prohibited, without the approval of the Minister, from reducing by 15% or more its total statutory capital, as set out in its previous year's financial statements; and (iv) is required to report its failure to meet its minimum solvency margin to the Minister within 30 days after becoming aware of such failure or having reason to believe that such failure has occurred. CIRCL is also required to obtain an annual loss reserve opinion issued by a government approved loss reserve specialist. At December 31, 2001, CIRCL was required to maintain a minimum statutory capital and surplus of $0.9 million (2000 - $1.3 million). At that date statutory capital and surplus (deficit) was ($4.3) million (2000 - $0.8 million) and the requirement was therefore not met.
The Insurance Act provides a minimum liquidity ratio for general business. An insurer engaged in general business is required to maintain the value of its relevant assets at not less than 75% of the amount of its relevant liabilities. Relevant assets include cash and time deposits, quoted investments, unquoted bonds and debentures, first liens on real estate, investment income due and accrued, accounts and premiums receivable, reinsurance balances receivable and funds held by ceding reinsurers. There are certain categories of assets which, unless specifically permitted by the Minister, do not automatically qualify as relevant assets such as unquoted equity securities, investments in and advances to affiliates, real estate and collateral loans. The relevant liabilities are total general business insurance reserves and total other liabilities less deferred income tax and sundry liabilities (by interpretation, those not specifically defined), letters of credit and guarantees. At December 31, 2001, CIRCL was required to maintain relevant assets of at least $5.8 million (2000 - $17.2 million). At that date relevant assets were approximately $3.4 million (2000 -$23.7 million) and the requirement was therefore not met.
A Bermuda-registered 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 insurer and to report to the Minister and the Bermuda Registrar of Companies in respect of certain events. Unless the approval of the Minister is 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 is given in writing to the Minister of the intention to do so. Within 30 days of the principal representative's knowing or having reason to believe that the insurer the representative represents is likely to become insolvent or that an "event" has occurred, the principal representative must provide a written report to the Minister setting out all the particulars of the case that are available to the representative. Examples of such an "event" include failure by the insurer to comply substantially with a condition imposed upon the insurer by the Minister relating to a solvency margin or a liquidity or other ratio. The Company understands that CIRCL's principal representative fully complied with these requirements.
The Minister may appoint an inspector with extensive powers to investigate the affairs of an insurer if the Minister believes that an investigation is required in the interest of the insurer's policyholders or persons who may become policyholders. In order to verify or supplement information otherwise provided to him, the Minister may direct an insurer to produce documents or information relating to matters connected with the insurer's business. The Minister has not exercised such powers at this time, however management of CIRCL have been in contact with the Regulators to fully apprise them of current and intended action. Detailed discussions have also been held with CIRCL's principal creditors regarding the insolvency and the various alternatives of action that may be taken. Such creditors have communicated to the Minister their understanding of the situation.
If it appears to the Minister that there is a risk of the insurer becoming insolvent, the Minister may direct the insurer not to take on any new insurance business; not to vary any insurance contract if the effect would be to increase the insurer's liabilities; not to make certain investments; to realize certain investments; to maintain in Bermuda, or transfer to the custody of a Bermuda bank, certain assets; or to limit its premium income. The Minister has directed that CIRCL may not undertake any new insurance business.
It is the Company's intention not to pay additional funds to CIRCL for losses it has incurred. CIRCL's insolvency, therefore, will not have a material effect on the consolidated financial position of the Company.
Certain of the Company's subsidiaries are also subject to regulation as insurance intermediaries. Under the applicable regulations, an intermediary is responsible as a fiduciary for funds received for the account of the parties to the insurance or reinsurance transaction and is required to hold such funds in appropriate bank accounts subject to restriction on withdrawals and prohibitions on commingling.
The Company's insurance intermediaries include MGA's. MGA's produce, underwrite, and administer business produced and manage claims on behalf of insurance companies in certain states, and they are subject to regulation under state laws regarding licensure, fiduciary obligations with respect to premium, and the general management of the insurers' business.
The activities of Stirling Cooke Brown Insurance Brokers Limited as an insurance broker in the UK require it to be authorized by the General Insurance Standards Council. Authorization by this body involves continuing compliance with rules made by the Council, which require, among other things, that the company maintain a minimum level of solvency that it supply reports to the Council, and that it conduct its business in accordance with the conduct of business rules published by the Council.
OUTSTANDING LOSSES AND LOSS EXPENSES
Both Realm National and CIRCL maintain loss reserves to reflect anticipated future claims and claims expense payments. The Company establishes reserves for losses and loss adjustment expenses related to reported claims on the basis of the evaluations of independent claims adjusters and the Company's own claims staff. In addition, reserves are established for losses which have occurred but have not yet been reported and for adverse development of reserves on reported losses. The Company and its independent actuaries estimate claims and claims expenses arising for losses that have occurred but not yet been reported based upon the Company's and the insurance industry's experience, together with statistical information with respect to the probable number and nature of such claims.
The following table sets forth a reconciliation of beginning and ending reserves for losses and loss adjustment expenses:
The adverse development during 2000 and 2001 on prior years in continuing operations primarily reflects the strengthening of loss reserves at the Company's U.S.-based insurance carrier relating primarily to two programs terminated in 2000.
The adverse development during 1999, 2000 and 2001 on prior years in discontinued operations primarily reflects the increase in provisions for doubtful reinsurance recoveries of $2.1 million in 1999, $2.4 million in 2000 and $1.0 million in 2001 as discussed in Note 9 to the Consolidated Financial Statements, as well as an increase in claims frequency on one particular program that covers bodily injury and property risks in the construction industry. The provision is included in the balance sheet as a component of paid and outstanding losses recoverable from reinsurers. The provision is an estimate and amounts not collectible from reinsurers may ultimately be significantly greater or less than the provision established.
The Company's underwriting loss ratio (i.e. the ratio of net losses and net loss expenses to net premium earned) for 2001 for continuing operations was 77.5% (2000--92.8%).
The Company believes that the provision for outstanding losses and loss expenses is adequate to cover the ultimate net cost of losses and loss expenses incurred; however, such a provision is an estimate and the losses may ultimately be significantly greater or less than the provision established. The Company has limited historical loss experience available to serve as a basis for the estimation of ultimate losses. The Company's exposure to the effect of future movements in its loss reserves has been increased by the reduction in the level of reinsurance purchased by Realm National on its programs in 2000 and 2001.
The previous table represents a reconciliation of reserves in accordance with generally accepted accounting principals ("GAAP"). The following table reconciles the difference between those reserves and those contained in regulatory filings made by the Company's subsidiaries in accordance with statutory accounting practices ("SAP").
The following table presents the development of the Company's ongoing net reserves for 1996 through 2001. The top line of the table shows the estimated reserve for unpaid losses and loss adjustment expenses recorded at the balance sheet date for each of the indicated years. This amount represents the estimated amount of losses and loss adjustment expenses for claims that are unpaid at the balance sheet date, including losses that have been incurred but not yet reported to the Company. The table also shows the re-estimated amount of the previously recorded reserve based on experience as of the end of each succeeding year. The estimate changes as more information becomes known about the frequency and severity of claims for individual years. The "Cumulative Deficiency" represents the aggregate change in the estimates over all prior years. The Company's insurance entities were both purchased in 1996 so, accordingly, there has only been five years' movement in the Company's reserves. It should be noted that the following table presents an analysis of loss and loss expense development. Therefore, each amount in the table includes the effects of changes in reserves for all prior years.
The increase in reserves one year later, two years later, three years and four years later on 1997, 1998, 1999, and 2000 reserves reflects primarily the strengthening of loss reserves at the Company's U.S.-based insurance carrier relating primarily to two programs terminated in 2000.
The increase in net reserves one year later, two years later, three years later, four years later, and five years later on 1996, 1997, 1998, 1999 and 2000 reserves reflects primarily an increase in claims frequency on one particular program that covers bodily injury and property risks in the construction industry, and an increase in provisions for doubtful reinsurance recoveries discussed in Note 9 to the consolidated financial statements.
ITEM 2
ITEM 2 - -PROPERTIES
The Company's head office is located in Hamilton, Bermuda. This facility currently serves as the headquarters for the financial and administrative departments of the Company and the Company's Bermuda subsidiaries. The following table sets forth additional information concerning the Company's facilities:
APPROXIMATE PROPERTY SQUARE FEET LEASE EXPIRATION - --------------------------------------- ----------- ------------------------
Hamilton, Bermuda.......... 5,900 June 20, 2006 London, England............ 10,750 August 10, 2009 Dallas, Texas.............. 14,700 August 31, 2003 New York, New York......... 7,900 September 3, 2003 New York, New York......... 2,800 September 14, 2004 Bradenton, Florida......... 12,350 June 28, 2008 Boca Raton, Florida........ 13,750 January 15, 2005 Southington, Connecticut... 2,460 August 31, 2011
All of the Company's facilities are leased. Aggregate lease payments for 2001 were $1.9 million (2000 - $1.9 million). The Company anticipates that it will be able to extend these leases as they expire or, if necessary or desirable, locate substitute facilities on acceptable terms.
ITEM 3
ITEM 3 - -LEGAL PROCEEDINGS
(a) The trial in the proceedings which Sphere Drake Insurance Limited ("Sphere Drake") caused to be issued on February 29, 2000 in the London Commercial Court (equivalent to a civil complaint in U.S. jurisdictions) against two of the Company's U.K. subsidiaries, two former officers of those subsidiaries and others, is underway and currently is expected to conclude during the second quarter of 2002. Sphere Drake alleges, in substance, that each and every contract placed with it through its underwriting agent by the Company's U.K. broker subsidiary was commercially unreasonable. Sphere Drake further alleges that this was obvious to the broker and that, accordingly, the London Commercial Court should infer a conspiracy between the broker and the underwriting agent to defraud Sphere Drake, thereby allowing it to treat as void from the outset all of the inwards reinsurance contracts placed with Sphere Drake through its underwriting agent by the Company's broker subsidiary.
It is the opinion of management that the claims described in Sphere Drake's action are without merit and the case is being and will be defended vigorously.
(b) On December 6, 2001, a jury returned a verdict dismissing all of the claims asserted against the Company, together with one of its London subsidiaries and a former employee of that subsidiary, in a third party action in the New York State Supreme Court brought by AXA Reassurance S.A. ("AXA"). The verdict also encompassed all of the claims asserted against these same defendants by New Hampshire Insurance Company ("NHIC"). In that action, AXA had sought indemnity and damages resulting from its efforts to void reinsurance contracts entered into in connection with certain "reinsurance-backed gap film financing" arrangements ("Film Finance Covers") brokered by the Company's London subsidiary. Certain claims in the action relating to other parties remain to be resolved by the Court, with the result that a final judgment subject to appeal has not yet been entered.
On July 2, 2001, the third-party complaint filed by defendant AXA Corporate Solutions (U.K.) Ltd. ("ACS") against the Company, one of its London subsidiaries and a former employee of that subsidiary (the "SCB Defendants") in an existing action originally brought by the insured Silicon Valley Bank was dismissed without prejudice. The third party complaint had alleged fraudulent and/or wrongful inducement to contract allegedly resulting in exposure to liability for claims under another Film Finance Cover brokered by the Company's London subsidiary. ACS filed a motion seeking reconsideration of that decision, which motion was denied by the Court on March 18, 2002. Two of the Company's London subsidiaries were served with a separate third-party complaint in this action alleging claims for fraudulent inducement, negligent misrepresentation and fraud and deceit by a different insurer defendant, NHIC. The London subsidiaries have entered into a tolling agreement with NHIC that will suspend for the time being the prosecution of NHIC's claims as well as the running of the statute of limitations pertaining thereto.
Two of the Company's London subsidiaries have been named as third party defendants in a federal court action instituted by Silicon Valley Bank in California involving a different Film Finance Cover. These subsidiaries also were named as defendants in a federal district court action by NHIC, which action has been dismissed without prejudice. The tolling agreement referred to above also applies to these claims.
Two of the Company's London subsidiaries, together with other unrelated parties, have been named as third-party defendants in an existing action in the New York State Supreme Court, filed on March 16, 2001 by NHIC. Each pleading alleges identical claims of fraudulent inducement and negligent misrepresentation against two of the Company's London subsidiaries in connection with another Film Finance Cover. A motion to dismiss has been made and is awaiting decision by the court.
It is the opinion of management that the claims described in these actions are without merit and the cases are being and will be defended vigorously.
Certain of the Company's subsidiaries acted as brokers in connection with other Film Finance Covers which either have become the subject of inquiry by one or more of the parties involved therein, or which have given rise to disputes not directly involving the Company or its subsidiaries. Although no assurances can be given as to the outcome of these disputes or of other potential proceedings related to the Film Finance Covers and their effect on the Company, the Company believes, based on the information presently available to it, that any such effect should not have a material adverse effect on the Company's financial condition.
(c) Several arbitration proceedings currently are pending in England between reinsurers and ceding insurers relating to reinsurance transactions involving the personal accident excess of loss market in London ("LMX") for the account years 1993, 1994, 1995, 1996, 1997 and 1998. Although neither the Company nor its broker subsidiaries is a party to any of these arbitrations, certain of the Company's subsidiaries acted as a reinsurance broker for ceding insurer clients that are parties to certain of the arbitrations.
In addition, the Company's reinsurance subsidiary is party to one of the LMX arbitrations. This particular arbitration has been dormant for some time.
The reinsurers generally have alleged that they sustained losses due to an "artificial" spiral in the LMX market, the existence of which, as well as other information, was not disclosed to them by the ceding insurers or their reinsurance brokers. In others, there are specific misrepresentation and non-disclosure allegations that are not of a generic nature. As a consequence, these reinsurers have asserted that they are no longer obliged to honor their reinsurance agreements and have suspended payment of claims.
During 1998 and 1999 certain of the reinsurers and reinsureds that are parties to the arbitrations described above issued proceedings in the English courts against one or more of the Company's brokerage subsidiaries and one underwriting management subsidiary, apparently for the primary purpose of tolling the statute of limitations pending the outcome of the arbitrations. In one proceeding against the same subsidiaries, three former officers of the subsidiaries were also named. In none of these proceedings did the complainant specify an amount of damages sought. If one or more reinsurers succeed in avoiding its contracts in the pending arbitrations, it is possible that ceding insurer clients, on whose behalf the Company's broker subsidiaries placed the reinsurance, may seek to pursue a claim for indemnification or other claims against one or more of those subsidiaries. Similarly, if one or more of the reinsurers fail to avoid its contracts in the pending arbitrations, it also is possible that those reinsurers may seek to pursue some type of claim against one or more of those subsidiaries.
The Company understands that awards already have been made in favor of the reinsurer in three arbitrations. However, based on the Company's understanding of the reasons given by the arbitration panels for their awards in favor of the reinsurer in two of those cases, the Company does not believe there is any valid basis for its ceding insurer clients in those cases to assert a claim against the Company or its broker subsidiaries. The Company has insufficient information to make a valid assessment in relation to the third.
With the exception of: (a) one inactive proceeding which the subsidiaries have been informed will be withdrawn; and (b) two related proceedings pending against certain subsidiaries of the Company, and certain current and former officers of these subsidiaries, each of which is in an early procedural stage, all judicial proceedings against the Company's subsidiaries relating to these matters have been stayed or held in abeyance pursuant to standstill agreements or court order.
One of the arbitration awards referenced above allowed a reinsurer to avoid certain of its reinsurance contracts with a Lloyd's syndicate. According to reports in the London press, that award may have caused the syndicate's liabilities to increase beyond the financial resources available to it and its Names, requiring the syndicate to avail itself of the Lloyd's Central Fund. Thereafter, Lloyd's initiated an investigation of that syndicate and all "market participants," including the Company's U.K. subsidiaries. The Company is aware that the investigation is ongoing, but has no other information as to the progress of the investigation or when it will be completed.
The Company understands that substantial progress has been and continues to be made by various market participants in settling ongoing reinsurance disputes, including many of the market participants that are parties to the arbitrations and other proceedings described above. The Company understands that a settlement by certain market participants of reinsurance disputes arising in the 1994 year of account (the "1994 Year of Account Settlement") has been executed. The Company further understands that working groups have been established to attempt to arrive at similar settlements in respect of the 1995 and 1996 years of account.
A subsidiary of the Company has been notified of a potential claim by one of the parties to the 1994 Year of Account Settlement for the recovery of costs arising out of the settlement as well as for the costs and expenses incurred by the party in connection with its overall involvement in the LMX market. The subsidiary has denied any liability for this potential claim.
Although no assurances can be given as to the outcome of the pending U.K. arbitrations or pending or potential arbitration or judicial proceedings related to the LMX spiral reinsurance arbitrations and their effect on the Company, the Company believes, based on the information presently available to it, that any such effect should not have a material adverse effect on the Company's financial condition.
(d) Beginning in late 1998 and 1999, the reinsurance markets in which the Company historically has been involved experienced considerable disruption for a variety of reasons, including but not limited to the LMX market disputes described above and other disputes involving the North American workers' compensation reinsurance market. The effects of this disruption have continued up to the present time.
One result of this market disruption has been that certain reinsurers with whom the Company's broker subsidiaries placed business on behalf of ceding insurer clients suspended claims payments to those clients, as well as to the Company's insurance and reinsurance subsidiaries, in certain instances also claiming a right to rescind the reinsurance contracts. As a result, a number of arbitrations were commenced between Company clients and their reinsurers. The Company has endeavored consistently to provide support to its clients in connection with these proceedings. In one ongoing arbitration involving the Company's insurer subsidiary, Realm National, that company has succeeded in obtaining $4.8 million in interim relief from a reinsurer by order of the arbitration panel pending a final determination of the matters in issue, which is expected in the second quareter of the year.
In some instances, disputes or potential disputes have arisen concerning whether reinsurance was properly placed by the Company's broker subsidiaries. In other instances, the Company's ceding insurer clients have demanded indemnification by the Company if the client's reinsurance contracts ultimately are avoided by its reinsurers.
Although no assurances can be given as to the effect on the Company of the various disputes in the worker's compensation reinsurance market, or related arbitrations, the Company believes, based on the information presently available to it, that any such effect should not have a material adverse effect on the Company's financial condition.
(e) The Company is subject to other litigation and arbitration in the ordinary course of its business. While any of these proceedings contains an element of uncertainty, management presently believes the outcome of these currently pending proceedings will not have a material adverse effect on the Company's financial condition.
ITEM 4
ITEM 4 - -SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of shareholders during the fourth quarter of the fiscal year 2000.
PRINCIPAL EXECUTIVE OFFICERS OF THE REGISTRANT
The following sets forth certain information regarding the Principal Executive Officers of the Company at March 18, 2001.
NAME AGE POSITION ---- --- --------------------------------- Stephen A. Crane......... 56 President, Chief Executive Officer and Director (1) Len Quick................ 59 Chief Operating Officer and Director (2) Anthony J. Del Tufo...... 57 Chief Financial Officer James Lawless, IV........ 47 Senior Vice President, General Counsel and Corporate Secretary
(1) Term as Director expires at Annual General Meeting in 2002.
(2) Term as Director expires at Annual General Meeting in 2003.
STEPHEN A. CRANE was appointed as President & Chief Executive Officer in November, 1999. Prior to joining the Company, Mr. Crane served for five years as President & Chief Executive Officer of Gryphon Holdings Inc., a specialty property-casualty underwriting organization.
LEN QUICK was appointed as Chief Operating Officer in July, 1999, having previously served as Chief of Operations of the Company's North American-based subsidiaries from 1997. Between 1994 and 1997, Mr. Quick was President of the Company's Dallas-based subsidiary, North American Risk Inc.
ANTHONY J. DEL TUFO was appointed acting Chief Financial Officer in October 2001. Mr. Del Tufo had been serving since June as the acting Chief Financial Officer of Realm National Insurance Company, a subsidiary of Stirling Cooke. Prior to assuming that role, he was Chief Financial Officer of W.R. Berkley Corporation. Mr. Del Tufo had also been a partner in the insurance auditing practice of KPMG.
JAMES LAWLESS, IV was appointed Senior Vice President, General Counsel and Corporate Secretary in March 2000. In the five-year period prior to joining the Company, Mr. Lawless practiced law in New York with LeBouef Lamb Green and MacRae, Werner & Kennedy and Battle Fowler LLP.
PART II
ITEM 5
ITEM 5 - -MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
The Company's ordinary shares, $0.25 par value, have been quoted on the Nasdaq National Market under the symbol "SCBHF" since November 26, 1997. The ordinary shares were listed in connection with the Company's initial public offering completed in December 1997. As of March 18, 2002, the approximate number of holders of the Company's ordinary shares was 900.
The following table sets forth the high and low closing sale prices per share of the Company's ordinary shares on the Nasdaq national market for the calender quarters of 2000 and 2001:
HIGH LOW ------ ----- Year ended December 31, 2000 First Quarter................................ $3-11/16 $1-7/8 Second Quarter............................... $3-1/8 $1-13/16 Third Quarter................................ $2-1/4 $1-15/16 Fourth Quarter............................... $2 $1 Year ended December 31, 2001 First Quarter................................ $1.63 $0.75 Second Quarter............................... $2.03 $0.98 Third Quarter................................ $2.04 $1.47 Fourth Quarter............................... $1.58 $0.61
The closing sale price per share of the Company's ordinary shares on the Nasdaq national market on March 18, 2002 was $0.55.
On February 14, 2002, the Company was advised by Nasdaq that it was not in compliance with certain Nasdaq Marketplace Rules, specifically those relating to the minimum bid price of the Company's Ordinary Stock and the minimum market value of its publicly held shares. The Company was further advised that it would have until May 15, 2002 within which to regain compliance with the Marketplace Rules, failing which the Company would be provided with written notification that its securities would be delisted. The Company would be able to appeal any such determination to the Nasdaq Listing Qualifications Panel. The Company has the option, prior to May 15, 2002, to apply to transfer its securities to The Nasdaq SmallCap Market, which application would have the effect of staying notification of delisting but, in the event that the Company's transfer application were not approved, notification of delisting would then be issued, again subject to a possible appeal. The Company cannot presently determine whether it will be in compliance with the applicable Marketplace Rules by May 15, 2002, and is evaluating the decision to file an application to transfer its securities to The Nasdaq SmallCap Market.
During 2001 the Company paid three quarterly dividends of $0.03, and in the fourth quarter discontinued the payment of quarterly dividends for the foreseeable future. During 2000, the Company paid quarterly dividends of $0.03 per ordinary share. The declaration and payment of future dividends is at the discretion of the Company's Board of Directors and will depend upon, among other things, future earnings, capital requirements, the general financial condition of the Company, general business conditions and other factors. The Company's ability to pay dividends is partially restricted due to various insurance regulations and tax considerations relating to certain of its subsidiaries. See "Management Discussion and Analysis of Financial Condition and Results of Operations" and Note 18 to the Consolidated Financial Statements.
During 1999, the Company purchased 356,400 ordinary shares on the open market at a total cost of $4,423,000. These shares were recorded as treasury stock at cost. The Company now holds a total of 443,400 ordinary shares in treasury at a total cost of $5.7 million.
In November 2000, the Company issued 100,000 restricted shares to Mr. Stephen A. Crane. The shares issued are subject to certain transfer restrictions which lapsed with respect to 33 1/3% of these shares on the date of their issuance and 33 1/3% of these shares in November 2001. Restrictions on the balance of the shares will lapse in November 2002, contingent on Mr. Crane's continued employment with the Company.
Under current Bermuda law, there is no Bermuda income tax, withholding tax, captial gains or capital transfer tax on the Company or its shareholders in respect of the payment of dividends or capital transactions.
ITEM 6
ITEM 6 - -SELECTED FINANCIAL DATA
The selected consolidated financial data below should be read in conjunction with the Consolidated Financial Statements and the notes thereto presented under Item 8.
ITEM 7
ITEM 7 - -MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following is a discussion of the Company's results of operations and financial condition. This discussion and analysis should be read in conjunction with the consolidated financial statements and the notes thereto presented under Item 8.
Results of Operations For the Years Ended December 31, 2001, 2000 and 1999.
Net loss from operations for 2001 was $21.3 million, compared to 2000 net loss from operations of $27.0 million and 1999 net loss from operations of $6.7 million.
Net loss from continuing operations before discontinued segments for 2001 was $15.1 million, compared to a net loss from continuing operations before discontinued segments of $16.0 million in 2000 and net loss from continuing operations before discontinued segments of $4.8 million in 1999. The results for the year for continuing operations were affected by a number of different factors. The U.S. workers' compensation market, in which the Company conducts most of its business, remained a difficult environment in which to operate. The Company's risk-taking insurance segment recorded increased underwriting losses for the year, primarily arising from programs which were discontinued in 2000. The program business segment suffered increased losses for the year, primarily due to costs and provisions pertaining to the consolidation of its Dallas MGA with its Boca Raton MGA and a charge of $2.9 million for future losses that the Company projects it will pay in connection with its indemnification of its major issuing company for losses in excess of a specific loss ratio on business produced by the MGA's during 2000. The brokerage segment also recorded a loss for the period, primarily due to a significant decrease in business being brokered following the substantially diminished reinsurance capacity for workers' compensation business. The Company is continuing with its restructuring program begun in 1999 in an effort to reduce expenses and increase efficiencies. The Company also continued to suffer from continuing costs and provisions pertaining to reinsurance-related disputes in which the Company and others were involved during the year, including certain litigation.
Revenues from continuing operations of $50.0 million in 2001 represented a $0.9 million decrease versus 2000 revenues from continuing operations of $50.9 million, which were $9.7 million below 1999 revenues from continuing operations of $60.6 million. Net loss from operations of $21.3 million in 2001 compares to a net loss from operations of $27.0 million in 2000 and net loss from operations of $6.7 million in 1999. The decline in revenues from continuing operations in 2001 reflected the difficult market conditions in the brokerage and program business segments, which were partially offset by increased net premium volume written and earned in the insurance segment as the insurance segment retained more busines by reducing the amount of reinsurance purchased for its programs. Expenses from continuing operations, including insurance costs, of $66.4 million in 2001 represent a $3.0 million decrease from 2000 expenses from continuing operations of $69.4 million, which increased $1.4 million over 1999 expenses from continuing operations of $68.0 million. Insurance costs for the year 2001 increased to $26.9 million, compared to $22.6 million in 2000 and $10.1 million in 1999. The increase in insurance costs for the year was primarily due to the increase in net premiums earned.
Total expenses from continuing operations excluding insurance costs for the year 2001 were $39.5 million, versus $46.8 million in 2000 and $57.9 million in 1999. This decrease in expenses from continuing operations reflects the effects of the restructuring program begun in 1999, together with a general reduction in administrative costs as a result of reduced business volume. This decrease in expenses from continuing operations was partially offset by costs and provisions pertaining to its Dallas MGA. In a continuing effort to streamline operations and reduce ongoing costs, the Company consolidated its Dallas MGA office with its Boca Raton MGA office. The Company recognized restructuring costs of $1.1 million associated with this merger, and those expenses were charged to fourth-quarter and full-year results. Consistent with this decision, the Company wrote off $0.7 million of remaining goodwill associated with the Dallas MGA. Finally, there was a charge of $2.9 million for future losses that the Company projects it will pay in connection with its indemnification of its major issuing company for losses in excess of a specific loss ratio on business produced by the MGA's during 2000. In addition, expenses from continuing operations continued to be impacted by costs and provisions pertaining to reinsurance-related disputes in which the Company is involved, including certain litigation.
Basic net loss per share was $2.24 in 2001, as compared to basic net loss per share of $2.86 in 2000 and basic net loss per share of $0.71 in 1999. Diluted net loss per share was $2.24 in 2001, as compared to diluted net loss per share of $2.86 in 2000 and diluted net loss per share of $0.71 in 1999.
Insurance - ---------
The Company's insurance segment consists of its wholly owned U.S.-based insurance company, Realm National Insurance Company. Insurance segment revenues of $29.9 million in 2001 represented an increase of $6.4 million from insurance segment revenues of $23.5 million in 2000, which reflected a $10.9 million increase from insurance segment revenues of $12.6 million in 1999. Gross written premiums were $40.0 million in 2001, which represented a $21.4 million decrease from $61.4 million in 2000, which in turn reflected a $14.2 million increase from $47.2 million in 1999. Net premiums earned were $27.8 million in 2001, which represented a $9.3 million increase from $18.5 million in 2000, which was a $9.0 million increase from $9.5 million in 1999. Policy issuance fees were $0.5 million in 2001, which represented a $2.7 million decrease from $3.2 million in 2000, which was a $0.7 million increase from $2.5 million in 1999. The increase in insurance segment revenues reflects an increase in net premium earned. Gross written premium decreased due to the decision to discontinue certain loss-making programs in 2000. Despite the decrease in gross premiums, net premiums written and earned increased as a result of reduced reinsurance ceded.
Loss before tax for the insurance segment of $2.6 million in 2001 represented an improvement of $2.4 million from loss before tax of $5.0 million in 2000, which in turn had increased $2.9 million from loss before tax of $2.1 million in 1999. The decreased loss before tax resulted from an improvement in losses incurred on business written.
The World Trade Center disaster of September 11, 2001 had an immaterial effect on the results of operations of Realm National and the Company for the year ended December 31, 2001.
Program Business - ----------------
The Company's program business segment consists of subsidiaries that market insurance products and administer programs developed by the Company. Program business revenues of $11.4 million in 2001 represented a decrease of $3.9 million from program business revenues of $15.3 million in 2000, which had decreased $7.1 million from program business revenues of $22.4 million in 1999. This decrease was due to reduced fee margins on programs and a reduction in program business volume due to management's decision to impose more selective underwriting conditions on continuing programs.
The program business segment loss before tax of $7.6 million in 2001 represented an increase in loss before tax of $2.1 million from loss before tax of $5.1 million in 2000, which had increased $2.4 million from loss before tax of $2.7 million in 1999. In a continuing effort to streamline operations and reduce ongoing costs, the Company consolidated its Dallas MGA office with its Boca Raton MGA office. The Company recognized restructuring costs of $1.1 million associated with this merger, and those expenses were charged to fourth-quarter and full-year results. Consistent with this decision, the Company wrote off $0.7 million of remaining goodwill associated with the Dallas MGA. Finally, there was a charge of $2.9 million for future losses that the Company projects it will pay in connection with its indemnification of its major issuing company for losses in excess of a specific loss ratio on business produced by the MGA's during 2000.
Brokerage - ---------
The Company's brokerage segment consists of subsidiaries that receive a fee or commission for brokering insurance and reinsurance contracts. Brokerage segment revenues of $5.8 million in 2001 represented a decrease of $5.4 million from brokerage segment revenues of $11.2 million in 2000, which had decreased $13.7 million from brokerage segment revenues of $24.9 million in 1999. This decrease in brokerage segment revenues was primarily the result of reduced business being brokered due to significantly diminished reinsurance capacity for workers' compensation business. In addition, the segment has been adversely affected by the disruption caused by widespread reinsurance market disputes and legal proceedings including those involving the Company.
The brokerage segment's loss before tax of $4.3 million in 2001 represented an improvement of $0.5 million from loss before tax of $4.8 million in 2000, which had decreased $7.5 million from income before tax of $2.7 million in 1999. The 2001 net loss reflects the decrease in revenues, which was offset by a decrease in brokerage segment expenses. Expenses for the segment continued to be impacted by significant costs and provisions associated with widespread reinsurance disputes involving the Company or its clients, including certain litigation.
Other - -----
Other revenues include primarily the Company's holding companies and other non-operating subsidiaries, as well as provisions against investments in non-consolidating affiliates. Other revenues of $2.9 million in 2001 represented an increase of $2.0 million from other revenues of $0.9 million in 2000, which in turn reflected an increase of $0.2 million from other revenues of $0.7 million in 1999. Loss before tax for the year was $1.9 million, compared to a loss before tax of $3.6 million in 2000 and income before tax of $5.7 million in 1999. The improvement in revenues and income from 2000 to 2001 was the result of a gain on sale of an investment of $1.1 million during the year, a write-back of a provision in an investment that was taken in the previous year, and partially offset by decreased interest income earned that was due to falling interest rates. The loss before tax for the year primarily reflects costs in respect of ongoing operating expenses.
Discontinued operations - -----------------------
Following a review of its operations in early 2001, the Company decided to discontinue its loss-making reinsurance and underwriting management segments effective December 31, 2000. In light of this decision, the Company took a charge against income in 2000 of $5.2 million to write off goodwill in respect of these operations.
The Company's discontinued underwriting management segment comprised companies that primarily underwrote and administered reinsurance business on behalf of independent reinsurance companies. Underwriting management revenues of $0.6 million in 2001 represented a decrease of $1.0 million from underwriting management revenues of $1.6 million in 2000, which had decreased $2.5 million from underwriting management revenues of $4.1 million in 1999.
Underwriting management loss before tax of $0.5 million in 2001 represented an improvement of $4.4 million from loss before tax of $4.9 million in 2000, which in turn reflected a $6.7 million decrease from income before tax of $1.8 million in 1999. In view of the reduction in underwriting management revenues, the resulting net loss, and the ongoing business prospects for the segment, the Company decided to discontinue the underwriting management segment effective December 31, 2000. The net loss for the year 2000 reflects the decreased revenues, together with a write-off of associated goodwill following the decision to discontinue these operations.
The Company's discontinued reinsurance segment consisted of its reinsurance subsidiary, CIRCL. CIRCL primarily reinsured workers' compensation and property and general liability risks. Reinsurance segment revenues of ($0.1) million in 2001 represented a decrease of $1.8 million from reinsurance segment revenues of $1.7 million in 2000, which in turn had decreased $1.4 million from reinsurance segment revenues of $3.1 million in 1999. Net premiums earned of ($0.3) million in 2001 represented a decrease of $1.2 million from net premiums earned of $0.9 million in 2000, which in turn reflected a $1.5 decrease from net premiums earned of $2.4 million in 1999.
Reinsurance segment loss before tax of $5.7 million in 2001 represented an improvement of $0.4 million from loss before tax of $6.1 million in 2000, which in turn was a increase in loss of $2.7 million from loss before tax of $3.4 million in 1999. The primary reason for the loss before tax during 2001 was a strengthening of reserves on discontinued programs, together with an increase of $1.0 million in provisions against reinsurance recoveries. CIRCL has experienced substantial delays in collection of reinsurance recoverables from certain of its reinsurers. CIRCL therefore has established a provision in the amount of $8.0 million against reinsurance contracts with projected reinsurance recoverables of a total of $61.0 million. This provision has been included in the balance sheet as a reduction of paid losses recoverable from reinsurers and outstanding losses recoverable from reinsurers. The above increases in loss reserves caused CIRCL's shareholder equity to become negative in the third quarter of 2001. It is the Company's intention not to pay additional funds to CIRCL for losses it has incurred. CIRCL's insolvency, therefore, will not have a material effect on the consolidated financial position of the Company.
Liquidity and Capital Resources - -------------------------------
At December 31, 2001, the Company held cash and marketable securities of $46.6 million, compared to $76.0 million at December 31, 2000. In addition, the Company held cash in fiduciary accounts relating to insurance client premiums amounting to $33.8 million at December 31, 2001, compared to $39.0 million at December 31, 2000. These decreased cash balances reflect the slow-down in the Company's business activities for 2001, the impact of delays in receiving outstanding reinsurance recoveries, and the net loss for the year. Of the $46.6 million of cash and marketable securities held by the Company at year end, $29.4 million (2000--$49.3 million) was held by subsidiaries whose payment of dividends to the Company was subject to regulatory restrictions or possible tax liabilities. At December 31, 2001, the Company's investment portfolio (at fair market value) totalled $30.1 million (2000--$34.6 million). The portfolio consisted primarily of U.S. Treasury obligations, short-term cash and A-rated corporate debt securities.
During the year ended December 31, 2001, the Company's operating activities used $29.2 million of net cash, compared to using $7.8 million of net cash during 2000 and $4.1 million in 1999. The cash used by operating activities varies according to the Company's net loss and the timing of collections and payments of the Company's insurance and reinsurance balances. In light of continuing losses, the Company is continuing to review all operations and take steps to restructure those operations in an attempt to reduce cash usage.
The increase of $168.0 million in insurance and reinsurance balances receivable, and the corresponding increase of $141.3 million in insurance and reinsurance balances payable, primarily reflects the growth in clients' claims balances recorded in the Company's broking subsidiaries. As a result of various disputes between insurers and reinsurers on various reinsurance contracts, a number of the reinsurers have suspended paying claims due under the contracts. The Company's brokerage and underwriting management segment subsidiaries experienced a significant growth in client balances receivable and payable recorded at the end of the year, reflecting this accumulation of claims due from one party to another. These balances are reflected as an asset or liability, as the case may be, on the Company's balance sheet.
The Company used $4.4 million during the year ended December 31, 1999 to repurchase 356,400 of its own shares on the open market.
Shareholders' equity decreased by $21.4 million, to $35.5 million, at December 31, 2001 from $56.9 million at December 31, 2000, due primarily to the net loss incurred for the year.
On February 14, 2002, the Company was advised by Nasdaq that it was not in compliance with certain Nasdaq Marketplace Rules, specifically those relating to the mimnimum bid price of the Company's Ordinary Stock and the minimum market value of its publicly held shares. The Company was further advised that it would have until May 15, 2002 within which to regain compliance with the Marketplace Rules, failing which the Company would be provided with written notification that its securities would be delisted. The Company would be able to appeal any such determination to the Nasdaq Listing Qualifications Panel. The Company has the option, prior to May 15, 2002, to apply to transfer its securities to The Nasdaq SmallCap Market, which application would have the effect of staying notification of delisting but, in the event that the Company's transfer application were not approved, notification of delisting would then be issued, again subject to a possible appeal. The Company cannot presently determine whether it will be in compliance with the applicable Marketplace Rules by May 15, 2002, and is evaluating the decision to file an application to transfer its securities to The Nasdaq SmallCap Market.
The Company had no outstanding debt at December 31, 2000 and 2001.
Critical accounting policies and estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions for those transactions that are not yet complete or for which the ultimate effects cannot be precisely determined. Such estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The most significant estimates include those used in determining the liability for outstanding losses and loss expenses, uncollectible insurance and reinsurance balances receivable and recoverable, and potential losses from litigation. Although some variability is inherent in these estimates, management believes the amounts provided for are adequate. The Company has identified the following critical accounting policies and estimates utilized by management in the preparation of the Company's financial statements; losses and loss expenses, and premiums written, assumed and ceded.
Losses and loss expenses; Losses and related loss adjustment expenses are charged to income as they are incurred and are net of losses recovered and recoverable. Amounts recoverable from reinsurers are estimated in a manner consistent with the underlying liability associated with the reinsured policy. Outstanding losses recoverable are shown separately on the consolidated balance sheets. The Company establishes reserves for losses and loss adjustment expenses related to reported claims on the basis of the evaluations of independent claims adjusters and the Company's own claims staff. In addition, reserves are established for losses which have occurred but have not yet been reported and for adverse development of reserves on reported losses. The Company's independent actuaries estimate claims and claim expenses arising for losses that have occurred but not yet been reported based upon the Company's and the insurance industry's experience, together with the statistical information with respect to the probable number and nature of such claims. The program business established an accrual in 2001 in connection with an indemnification to its major issuing company. While the liability is not included in loss reserves, it is based on losses and is subject to the same estimation processes discussed above. The Company believes that the provision for outstanding losses and loss expenses is adequate to cover the ultimate net cost of losses and loss expenses incurred; however, such a provision is an estimate and may ultimately be significantly greater or less than the provision established. The Company has limited historical loss experience available to serve as a basis for the estimation of ultimate losses. It is possible that management will revise the estimate of outstanding losses and loss expenses in the future.
Premiums written, assumed and ceded; Premiums written and assumed are recorded on an accrual basis and included in income on a pro-rata basis over the life of the policies or reinsurance agreements to which they relate, with the unearned portion deferred in the consolidated balance sheets. Adjustment premiums arising from premium audits are recorded in the period in which they are determined. Reinsurance premiums ceded are similarly pro-rated over the terms of the reinsurance contract with the unearned portion being deferred in the consolidated balance sheets as deferred reinsurance premiums ceded.
Accounting Pronouncements - -------------------------
During 1998, the AICPA Accounting Standards Executive Committee issued Statement of Position ("SOP") 98-5, "Reporting on the Costs of Start-up Activities". The accounting guidance of this SOP requires that the costs of start-up activities be expensed as incurred and any costs that are carried as an asset prior to adoption of SOP 98-5 would be written off by reporting a cumulative effect of a change in accounting principle in the statement of income as of January 1, 1999. The cumulative effect of a change in accounting principle that was recorded in the statement of income for the first quarter of 1999 was approximately $307 (net of tax of $188).
In June 1999, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS") No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133". This statement amends SFAS No. 133 to defer its effective date for one year, to fiscal years beginning after June 15, 2000. In June 2000, the Financial Accounting Standards Board issued SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities." This statement is an amendment of SFAS No. 133 with respect to the accounting and reporting standards for certain derivative instruments and certain hedging activities. The Company adopted this standard effective January 1, 2001, and it did not have a significant impact on the Company's financial position or results of operations.
In June 2001, the FASB issued SFAS No. 141, "Business Combinations." SFAS No. 141 eliminates the pooling-of-interest method of accounting for business combinations, requiring all business combinations to be accounted for under the purchase method. Accordingly, net assets acquired are recorded at fair value, with any excess of cost over net assets assigned to goodwill. SFAS No. 141 also requires that certain intangible assets acquired in a business combination be recognized apart from goodwill. The provisions of SFAS No. 141 apply to all business combinations intiated after June 30, 2001. Use of the pooling-of-interest method of accounting for those transactions is prohibited. Adoption of SFAS No. 141 will not have a material impact on the Company's financial condition or results of operations.
In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets." Under SFAS No. 142, amortization of goodwill is precluded; however, its fair value is periodically (at least annually) reviewed and tested for impairment. Goodwill must be tested for impairment in the year of adoption, including an initial test performed within six months. If the initial test indicates a potential impairment, then a more detailed analysis to determine the extent of impairment must be completed within twelve months. SFAS No. 142 requires that useful lives for intangibles other than goodwill be reassessed and remaining amortization periods be adjusted accordingly. The reassessment must be completed prior to the first quarter of 2002. The provisions of SFAS No. 142 are effective for financial statements issued for fiscal years beginning after December 15, 2001. All provisions of SFAS No. 142 will be applied beginning January 1, 2002, to goodwill and other intangible assets. Goodwill amortization totaled $928 in 2001, and the Company expects it would have approximated $150 in 2002 before application of the non-amortization provisions of this statement. The Company is in the process of assessing the impacts from the implementation of the other provisions of SFAS No. 142.
In August 2001, the FASB issued Statement No. 144, "Accounting for the Impairment or Disposal of Long Lived Assets," which updates and clarifies the accounting and reporting for impairment of assets held in use and to be disposed of. SFAS No. 144, among other things, will require the Company to classify the operations and cash flow of properties to be disposed of as discontinued operations. The provisions of SFAS No. 144 are effective for financial statements issued for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years, with early application encouraged. The provisions of SFAS No. 144 generally are to be applied prospectively. The Company expects to adopt the provisions of the Statement January 1, 2002, and does not expect it to have a material impact on the Company's financial position or results from operations.
Note on Forward-Looking Statements - ----------------------------------
The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking statements. This Form 10-K, or any oral or written statements made by or on behalf of the Company, may include forward-looking statements which reflect the Company's current views with respect to future events and financial performance. These forward-looking statements are identified by their use of such terms and phrases as "intends," "intend," "intended," "goal," "estimate," "estimates," "expects," "expect," "expected," "project," "projected," "projections," "plans," "anticipates," "anticipated," "should," "designed to," "foreseeable future," "believe," "believes," "scheduled" and similar expressions. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date the statement was made. 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.
Reference is made to the cautionary statements contained in Exhibit 99 to this Form 10-K for a discussion of the factors that may cause actual results to differ from any results expressed or implied by these forward-looking statements.
Inflation - ---------
The Company does not believe its operations have been materially affected by inflation. The potential adverse impacts of inflation include: (a) a decline in the market value of the Company's fixed maturity investment portfolio; (b) an increase in the ultimate cost of settling claims which remain unresolved for a significant period of time; and (c) an increase in the Company's operating expenses. However, the Company generally holds its fixed maturity investments to maturity and currently believes that an acceptable amount is included in the yield to compensate the Company for the risk of inflation. Any increase in the cost of settling claims should be offset by increases in investment income earned and, generally, an increase in operating expenses resulting from inflation should be matched by similar increases in investment income earned on the Company's general surplus funds.
ITEM 7A
ITEM 7A - -MARKET RISK
The Company's investment portfolio is comprised of fixed-maturity investments, equity securities, and short-term investments. The Company's exposure to market risk is limited primarily to changing interest rates, primarily in the United States, as all fixed maturity investments are denominated in U.S. dollars. The fair value of the fixed-maturity investments at December 31, 2001 was $26.5 million. A change in interest rates will affect the fair value of the Company's investments and will lead to fluctuations in "Accumulated Other Comprehensive Income" on the balance sheet. The Company does not use derivative financial instruments to manage market risk in its portfolio.
The table below (expressed in millions of U.S. dollars) presents the par value amounts and related weighted average interest rates by year of maturity for the Company's U.S. dollar-denominated investment portfolio.
Given the limited value of balances and transactions in foreign currencies, the Company's exposure to foreign currency movements is considered to be insignificant.
ITEM 8
ITEM 8 - -FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index to Consolidated Financial Statements and Related Notes:
PAGE # Report of Independent Public Accountants........................ 23 Consolidated Balance Sheets..................................... 25 Consolidated Statements of Income and Comprehensive Income...... 26 Consolidated Statements of Changes in Shareholders' Equity...... 27 Consolidated Statements of Cash Flows........................... 28 Notes to Consolidated Financial Statements...................... 29-50
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
The Board of Directors and Shareholders of Stirling Cooke Brown Holdings Limited
We have audited the consolidated balance sheets of Stirling Cooke Brown Holdings Limited and subsidiaries as of December 31, 2000 and 2001, and the related consolidated statements of income and comprehensive income, changes in shareholders' equity and cash flows for each of the three years in the period ended December 31, 2001. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Stirling Cooke Brown Holdings Limited and subsidiaries as of December 31, 2000 and 2001 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001 in conformity with accounting principles generally accepted in the United States.
/s/ Arthur Andersen LLP
Arthur Andersen LLP New York, New York March 18, 2002
STIRLING COOKE BROWN HOLDINGS LIMITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 2000 AND 2001 (EXPRESSED IN THOUSANDS OF UNITED STATES DOLLARS, EXCEPT SHARE AND PER SHARE DATA)
1. GENERAL
Stirling Cooke Brown Holdings Limited was incorporated in Bermuda on December 12, 1995. Stirling Cooke Brown Holdings Limited and its majority-owned subsidiaries (collectively referred to as the "Company") provide insurance services and products. The Company provides its range of services and products to insurance and reinsurance companies, insurance agents, and insureds. The Company is involved primarily in the workers compensation, occupational accident and health and property/casualty insurance markets through its subsidiaries based in London, Bermuda and the United States. In January 1996, the Company acquired all the outstanding common shares of Realm Investments Ltd. in exchange for 1,999,980 of its newly issued ordinary shares. The Company also acquired, in September 1996, its own United States domiciled insurance company, Realm National Insurance Company ("Realm National"), which writes insurance business in the workers compensation and property/casualty insurance markets.
On December 2, 1997, the Company and certain selling shareholders consummated an initial public offering of 3,421,250 ordinary shares. Of these shares, 1,375,000 were sold by the Company and 2,046,250 were sold by selling shareholders. Net proceeds of $26,832 were received by the Company upon consummation of the initial public offering.
In early 2001, following a review of its operations, the Company decided to discontinue its reinsurance and underwriting management segments, as discussed in Note 3. In addition, the Company consolidated its Dallas, Texas Managing General Agency ("MGA") office with its Boca Raton, Florida MGA office, effective December 31, 2001.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accompanying consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States. The following are the significant accounting policies adopted by Stirling Cooke:
a) Basis of presentation
These consolidated financial statements include the financial statements of Stirling Cooke Brown Holdings Limited and all of its majority-owned subsidiaries. All significant intercompany balances and transactions have been eliminated on consolidation. The results of a number of subsidiaries have been included from the dates of their acquisition.
b) Use of estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions for those transactions that are not yet complete or for which the ultimate effects cannot be precisely determined. Such estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The most significant estimates include those used in determining the liability for outstanding losses and loss expenses, uncollectible insurance and reinsurance policies receivable and recoverable, and potential losses from litigation. Although some variability is inherent in these estimates, management believes the amounts provided for are adequate.
c) Marketable securities
Marketable securities comprise investments in debt and equity securities and short-term investments. All investments are classified as available for sale in accordance with SFAS 115, "Accounting for Certain Investments in Debt and Equity Securities". Accordingly, these securities are carried at fair value, with the difference between fair value and cost or amortized cost being recorded as accumulated other comprehensive income as a separate component of shareholders' equity, net of applicable deferred income taxes. Bond discounts and premiums are amortized over the remaining term of the securities. Such amortization is included as a component of net investment income in the consolidated statements of income. Realized gains and losses are determined on the basis of specific identification. Investment income is recorded as earned and accrued to the balance sheet date.
d) Premiums written, assumed and ceded
Premiums written and assumed are recorded on an accrual basis and included in income on a pro-rata basis over the life of the policies or reinsurance agreements to which they relate, with the unearned portion deferred in the consolidated balance sheets. Adjustment premiums arising from premium audits are recorded in the period in which they are determined. Reinsurance premiums ceded are similarly pro-rated over the term of the reinsurance contract, with the unearned portion being deferred in the consolidated balance sheets as deferred reinsurance premiums ceded.
e) Acquisition costs
Acquisition costs associated with the acquisition of new or renewal business, including commissions, premium taxes and brokerage, are deferred and amortized to expense over the periods in which the premiums are earned. The method followed in determining the deferred acquisition expenses limits the amount of the deferral to its realizable value by giving consideration to losses and expenses expected to be incurred as premiums are earned. Future investment income is also anticipated in determining whether a premium deficiency exists.
f) Losses and loss expenses
Losses and related loss adjustment expenses are charged to income as they are incurred and are net of losses recovered and recoverable of $53,863, $50,040 and $25,272 for the years ended December 31, 1999, 2000 and 2001 respectively. Amounts recoverable from reinsurers are estimated in a manner consistent with the underlying liability associated with the reinsured policy. Outstanding losses recoverable are shown separately on the consolidated balance sheets.
The Company establishes reserves for losses and loss adjustment expenses related to reported claims on the basis of the evaluations of independent claims adjusters and the Company's own claims staff. In addition, reserves are established for losses which have occurred but have not yet been reported and for adverse development of reserves on reported losses. The Company's independent actuaries estimate claims and claims expenses arising for losses that have occurred but not yet been reported based upon the Company's and the insurance industry's experience, together with statistical information with respect to the probable number and nature of such claims. The Company believes that the provision for outstanding losses and loss expenses is adequate to cover the ultimate net cost of losses and loss expenses incurred; however, such a provision is an estimate and losses may ultimately be significantly greater or less than the provision established. The Company has limited historical loss experience available to serve as a basis for the estimation of ultimate losses. It is possible that management will revise the estimate of outstanding losses and loss expenses in the future.
g) Recognition of risk management fees
FOR THE YEARS ENDED ------------------- DECEMBER 31, ------------ 1999 2000 2001 ------- -------- -------- Brokerage fees and commissions............... $24,577 $ 8,920 $ 4,771 Managing general agency fees................. 10,164 8,974 6,240 Program and captive management fees.......... 2,298 483 151 Loss control and audit fees.................. 7,577 5,358 4,883 Policy issuance fees......................... 2,495 3,230 461 ------- -------- -------- Total risk management fees.... $47,111 $ 26,965 $ 16,506 ======= ======== ========
Underwriting management fees from discontinued segment................. $ 3,900 $ 1,281 $ 599 ======= ======== ========
(i) Brokerage fees and commissions are recorded and earned as premiums are billed since substantially all placement services have been provided at that time. Any subsequent adjustments, including adjustments due to policy cancellations, premium rate adjustments and profit commissions are recognized in risk management fees when advised by the client.
(ii) Managing general agency fees are included within program business segment revenue and are reported net of commission expense to agents. These fees and are initially recorded as of the effective date of the related insurance policy and are recognized in income over the period of the underlying policy (which is typically one year). Fees for claims handling services are recognized in income over the period that services are performed in accordance with the Company's contractual obligations, typically ranging up to five years, based on the Company's estimation of expected claims handling requirements in each accounting period. Such estimation is based upon industry standards. Any subsequent adjustments, including adjustments due to policy cancellation and premium adjustments, are recorded when advised by the client or agent. The portion that will be earned in the future is deferred and reported as deferred income in the consolidated balance sheets.
(iii) Program and captive management fees are included within program business segment revenue, and are initially recorded as of the effective date of the insurance policy or, in the case of installment premiums, when the installment is billed and are earned in income over the period of the underlying policy (which is typically one year) in proportion to the level of services provided in accordance with the Company's contractual obligations. Any subsequent adjustments are recognized in income when advised by the client or agent. The portion of recorded management fees that will be earned in the future is deferred and reported as deferred income in the consolidated balance sheets.
(iv) Loss control and audit fees are included within program business segment revenue, and comprise claims administration handling, loss and safety control fees and premium audit fees. Such fees are recorded as the fees are billed and are recognized in income over the period that services are performed in accordance with the Company's contractual obligations, typically ranging up to five years, depending on the type of service provided, and based on the Company's estimation of expected claims handling requirements in each accounting period. Such estimation is based upon industry standards. The proportion that will be earned in the future is deferred and reported as deferred income in the consolidated balance sheets.
(v) Policy issuance fees are recorded as the premium is written and earned over the applicable policy period (which is typically one year). The unearned portion is included in deferred income in the consolidated balance sheet.
(vi) Underwriting management fees are initially recorded and earned when the premium is billed in accordance with terms of trade. Fee income for claims handling services is recognized in income over the period that services are performed in accordance with the Company's contractual obligations. Such fees are recognized in income over the period that contractual services are performed, typically up to five years, based on the Company's estimation of expected claims handling requirements in each accounting period. Such estimation is based upon the Company's claims handling experience over recent years. Any subsequent adjustments, including adjustments due to policy cancellations and premium adjustments, are recorded when advised by the client or agent. The portion of recorded fees that will be earned in the future is deferred and reported as deferred income in the consolidated balance sheets.
h) Cash and cash equivalents
The Company considers time deposits with original maturity dates of three months or less to be equivalent to cash. Fiduciary funds are restricted from use and are not considered cash equivalents.
i) Investments in affiliates
The Company's investments in affiliated companies that are not majority owned or controlled are accounted for using the equity method if the Company is able to exert significant influence upon such companies. Other investments in affiliates are carried at cost. Investments in affiliates of $248 and $171 as of December 31, 2000 and 2001, respectively, are recorded in other assets. The Company's equity share in the net income of affiliates, for the years ended December 31, 1999, 2000 and 2001 was $Nil. In addition, for 1999, the Company recorded a write-down of $2,018 in Other income (loss) to recognize a decrease in the value of several of its equity holdings. Dividends received from affiliated companies were $Nil during 1999, 2000 and 2001.
j) Goodwill
Goodwill in the amounts of $1,969 and $1,041 at December 31, 2000, and 2001, respectively, represents the excess of purchase price over fair value of net assets acquired. Goodwill is amortized on a straight-line basis over the expected periods to be benefited, generally 5 to 20 years. Accumulated amortization at December 31, 2000 and 2001 was $9,399 and $10,327, respectively. The Company assesses the recoverability of this intangible asset by determining whether the amortization of the goodwill balance over its remaining life can be recovered through undiscounted future operating cash flows of the acquired operation. The amount of goodwill impairment, if any, is measured based on projected discounted future operating cash flows using a discount rate reflecting the Company's average cost of funds. The Company consolidated its Dallas, Texas Managing General Agency ("MGA") office with its Boca Raton MGA office effective December 31, 2001. In light of this decision, the Company took a charge of $654 against operations in 2001 in respect of a write-off of goodwill. In addition, following a review of its operations, the Company decided on March 6, 2001 to discontinue its reinsurance and underwriting management segments. In light of this decision and following a comprehensive review of the value of all of its intangible assets, the Company took a charge against operations in the year 2000 in respect of the write-off of a significant portion of its goodwill. The write-off of goodwill, together with the annual amortization, resulted in a total charge against operations for the year 2000 of $6,695, the majority of which related to the write-off of goodwill in respect of discontinued segments.
k) Capital assets and depreciation
Capital assets are stated at cost less accumulated depreciation. Depreciation is calculated using the straight-line method over four to five years, which are the estimated useful lives of the related assets.
l) Earnings (loss) per share
Earnings (loss) per share have been calculated in accordance with Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share". Net income (loss) per share is calculated by dividing income (loss) available to ordinary shareholders by the weighted average number of ordinary shares outstanding. Shares held in treasury are not considered outstanding for purposes of the computation. Net income (loss) per share assuming dilution is computed by dividing income available to ordinary shareholders by the weighted average number of ordinary shares and potentially dilutive securities such as stock options. During the years 1999, 2000 and 2001 stock options were not included in the calculation as the effect would be anti-dilutive.
m) Income taxes
Under the asset and liability method used by the Company as outlined in SFAS No. 109, "Accounting for Income Taxes", deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the consolidated financial statements' carrying amounts of existing assets and liabilities and their respective tax bases. A valuation allowance is provided for a portion or all of the deferred tax assets when it is more likely than not that such portion or all such deferred assets will not be realized.
n) Foreign exchange
The United States Dollar is the Company's functional currency. Foreign currency monetary assets and liabilities are translated at exchange rates in effect at the balance sheet date. Fixed assets and deferred income are translated at their historical exchange rates. Foreign currency revenues and expenses are translated at exchange rates in effect at the date of the transaction. Net exchange losses of ($117), ($392) and ($333) were recorded for the years ended December 31, 1999, 2000 and 2001, respectively.
o) Derivative financial instruments
During the year, the Company was a party to transactions in certain derivative financial instruments, specifically, forward foreign exchange contracts which are used to manage foreign currency exposures on non-U.S. dollar denominated assets and liabilities. The Company does not engage in derivatives for any other purpose. The Company's policy on such derivatives is that forward foreign exchange contracts are recorded at their fair value, and the fair values of open contracts are based on the quoted market prices of forward contracts with similar maturities. Changes in fair values are recognized in other income as appropriate in the period in which the changes occur. Amounts receivable or payable on open positions are recorded in other assets or accounts payable and accrued liabilities as appropriate. See Note 15(c).
p) Stock compensation plans
As permitted by SFAS No. 123, "Accounting for Stock-Based Compensation", the Company has elected to continue to account for stock option grants in accordance with APB Opinion No. 25, "Accounting for Stock Issued to Employees", and, accordingly, recognizes compensation expense for stock option grants to the extent that the fair value of the stock exceeds the exercise price of the option at the measurement date. Any resulting compensation expense is recorded over the shorter of the vesting or service period.
q) Accounting pronouncements
During 1998, the AICPA Accounting Standards Executive Committee issued Statement of Position ("SOP") 98-5, "Reporting on the Costs of Start-up Activities". The accounting guidance of this SOP requires that the costs of start-up activities be expensed as incurred and any costs that are carried as an asset prior to adoption of SOP 98-5 would be written off by reporting a cumulative effect of a change in accounting principle in the statement of income as of January 1, 1999. The cumulative effect of a change in accounting principle that was recorded in the statement of income for the first quarter of 1999 was approximately $307 (net of tax of $188).
In June 1999, the Financial Accounting Standards Board ("FASB") issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133". This statement amends SFAS No. 133 to defer its effective date for one year, to fiscal years beginning after June 15, 2000. In June 2000, the Financial Accounting Standards Board issued SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities." This statement is an amendment of SFAS No. 133 with respect to the accounting and reporting standards for certain derivative instruments and certain hedging activities. The Company adopted this standard effective January 1, 2001, and it did not have a significant impact on the Company's financial position or results of operations.
In June 2001, the FASB issued SFAS No. 141, "Business Combinations." SFAS No. 141 eliminates the pooling-of-interest method of accounting for business combinations, requiring all business combinations to be accounted for under the purchase method. Accordingly, net assets acquired are recorded at fair value with any excess of cost over net assets assigned to goodwill. SFAS No. 141 also requires that certain intangible assets acquired in a business combination be recognized apart from goodwill. The provisions of SFAS No. 141 apply to all business combinations initiated after June 30, 2001. Use of the pooling-of-interest method of accounting for those transactions is prohibited. Adoption of SFAS No. 141 will not have a material impact on the Company's financial condition or results of operations.
In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets." Under SFAS No. 142, amortization of goodwill is precluded; however, its fair value is periodically (at least annually) reviewed and tested for impairment. Goodwill must be tested for impairment in the year of adoption, including an initial test performed within six months. If the initial test indicates a potential impairment, then a more detailed analysis to determine the extent of impairment must be completed within twelve months. SFAS No. 142 requires that useful lives for intangibles other than goodwill be reassessed and remaining amortization periods be adjusted accordingly. The reassessment must be completed prior to the first quarter of 2002. The provisions of SFAS No. 142 are effective for financial statements issued for fiscal years beginning after December 15, 2001. All provisions of SFAS No. 142 will be applied beginning January 1, 2002, to goodwill and other intangible assets. Goodwill amortization totaled $928 in 2001, and the Company expects it would have approximated $150 in 2002 before application of the non-amortization provisions of this statement. The Company is in the process of assessing the impacts from the implementation of the other provisions of SFAS No. 142.
In August 2001, the FASB issued Statement No. 144, "Accounting for the Impairment or Disposal of Long Lived Assets," which updates and clarifies the accounting and reporting for impairment of assets held in use and to be disposed of. SFAS No. 144, among other things, will require the Company to classify the operations and cash flow of properties to be disposed of as discontinued operations. The provisions of SFAS No. 144 are effective for financial statements issued for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years, with early application encouraged. The provisions of SFAS No. 144 generally are to be applied prospectively. The Company expects to adopt the provisions of the Statement January 1, 2002, and does not expect it to have a material impact on the Company's financial position or results from operations.
r) Reclassifications
Certain amounts in 1999 and 2000 have been reclassified to conform with the current-year presentation. These reclassifications had no impact on net income or shareholders' equity.
3. DISCONTINUED OPERATIONS
Following a review of its operations, the Company decided on March 6, 2001 to discontinue its reinsurance and underwriting management segments and put these segments into run-off.
The Company's reinsurance segment consists of its reinsurance subsidiary, Comp Indemnity Reinsurance Company Limited ("CIRCL"). CIRCL primarily reinsured workers' compensation and property and general liability risks. Management determined in early 1999 to cease underwriting new programs in the reinsurance segment due to unfavourable results, and for this reason, a number of exisiting contracts were not renewed for the 1999 year. During 2000, further losses were realized in this segment, primarily due to a strengthening of reserves on discontinued programs, together with an increase in provisions against reinsurance recoveries. Due to the history of operating losses for the segment, together with the cessation of writing new programs, the Company decided to completely discontinue the segment and place the operation into run-off. At December 31, 2001, reinsurance segment assets were primarily cash and cash equivalents, insurance and reinsurance balances receivable, and paid and outstanding losses recoverable from reinsurers. Segment liabilities were primarily insurance and reinsurance balances payable, and outstanding losses and loss expenses.
The Company's underwriting management segment is comprised of companies that primarily underwrote and administered reinsurance business on behalf of independent reinsurance companies. Since 1999, the underwriting management segment has experienced a significant reduction in business written, which has led to decreasing revenues over the period. In view of the reduction in revenues, the resulting loss, and the ongoing business prospects for the segment, the Company decided to discontinue the segment and place the operation into run-off. At December 31, 2001, underwriting management segment assets were primarily cash and cash equivalents, and insurance and reinsurance balances receivable. Segment liabilities were primarily insurance and reinsurance balances payable.
As a result of the planned run-off of operations of the underwriting management and reinsurance segments, the operating results of the underwriting management and reinsurance segments in the accompanying financial statements have been reported as discontinued operations for all periods presented, and, accordingly, the operating results for periods prior to 2000 have been restated.
4. LETTERS OF CREDIT AND ASSETS HELD IN TRUST
In the normal course of insurance and reinsurance operations the Company's bankers have issued letters of credit totaling $14,609 and $7,629 at December 31, 2000 and 2001, respectively in favor of ceding insurance companies. At December 31, 2000 and 2001, $14,609 and $7,629, respectively, of cash and cash equivalents were pledged as collateral for these letters of credit.
One of the Company's subsidiaries was registered with the Society of Lloyd's as a registered Lloyd's Broker. Until July 3, 2000, as required by Lloyd's Brokers Byelaw (No. 5 of 1988), the subsidiary entered into a trust deed under which all insurance broking account assets were subject to a floating lien held in trust for the Society of Lloyd's for the benefit of the insurance creditors. With effect from July 3, 2000, in common with all Lloyd's Brokers, the security held under the trust deed was released as a result of changes to Lloyd's Distribution Policy enacted by Lloyd's Regulatory Bulletin dated May 31, 2000.
5. FIDUCIARY ASSETS AND LIABILITIES
In its various capacities as an insurance intermediary, the Company acts as a conduit for insurance and reinsurance premiums from insureds and other intermediaries, and after deducting its risk management fee and, where appropriate, surplus lines taxes and stamping fees, remits the premium to the respective insurance company or underwriter. Additionally, the Company acts as a conduit for loss payments. Pending the remittance of such funds to the insurance company or underwriter in accordance with the applicable insurance contract, the Company holds collected funds in its own segregated bank accounts and is entitled to any accrued interest on such funds. The obligation to remit these funds is recorded as insurance and reinsurance balances payable on the Company's balance sheet. The period for which the Company holds such funds is dependent upon the date the insured remits the payment of the premium to the Company and the date the Company is required to forward such payment to the insurer.
Insurance balances receivable of $1,039,012 (2000 -- $872,666) and payable of $1,051,703 (2000 -- $910,437) primarily consist of clients' claims and premiums balances recorded by the Company in its capacity as an intermediary. As a result of various disputes between insurers and reinsurers on various reinsurance contracts, a number of the reinsurers have suspended paying claims due under the contracts. The Company's brokerage and discontinued underwriting management segment subsidiaries have experienced a significant growth in claims due from one party to another. These balances are reflected as assets and liabilities of the Company in its role as an intermediary.
6. MARKETABLE SECURITIES
a) The cost or amortized cost and estimated fair value of marketable securities held as 'available for sale' are as follows:
Deferred tax liabilities of $24 and $61 at December 31, 2000 and 2001, respectively, have been provided against unrealized gains on marketable securities held as "available for sale", which have been presented net as accumulated other comprehensive income within shareholders' equity.
b) The amortized cost and estimated fair value of debt securities by contractual maturity are shown in the following table. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
DECEMBER 31, 20001 ------------------------ AMORTIZED ESTIMATED --------- --------- COST FAIR VALUE ---- ---------- Due in one year or less.................. $182 $183 Due after one year through five years.... 11,712 12,077 Due after five years through ten years... 10,031 10,189 Due after ten years through twenty years. 2,339 2,375 ------------------------ $24,264 $24,824
c) Proceeds from sales of investments in debt securities during 2000 and 2001 were $3,319 and $22,958, respectively. Proceeds from sales of investments in equity securities during 2000 and 2001 were $3,659 and $965, respectively. There were $27 of realized losses and $784 of realized gains during 2000. There were $110 of realized losses and $362 of realized gains during 2001.
d) At December 31, 2000 and 2001, debt securities having an amortized cost of $1,630 and $1,600, respectively, were on deposit with government authorities as required by law.
e) At December 31, 2000 and 2001, there were no individual investments, other than investments in U.S. Government securities, which exceeded 10% of shareholders' equity.
f) Net investment income by source, including realized gains and losses, is as follows:
7. CAPITAL ASSETS
Included within other assets are capital assets as follows:
8. DEPOSIT LIABILITIES AND RELATED ASSETS
Certain of the Company's reinsurance contracts, referred to as rent-a-captive programs, do not satisfy the conditions for reinsurance accounting as the maximum exposure to loss is fully funded by premium, cash and other collateral and indemnity agreements. Accordingly, these contracts are accounted for as deposit liabilities. The assets related to these programs represent funds under management as the insured retains the risks and rewards of ownership. Such assets are recorded as assets related to deposit liabilities in the consolidated balance sheets. These assets comprised cash and short-term deposits at December 31, 2000 and 2001. The Company receives a fee based on a percentage of premiums written and investment income earned for structuring and providing ongoing management of the programs.
In addition, deposit liabilities and related assets include $2,629 and $1,664 of deposits received from customers as security for the timely payment of premiums for workers' compensation insurance at December 31, 2000 and 2001, respectively. The deposit is restricted from use by the Company, and is the property of the customer. The deposit is refunded to the customer after the policy expires or is canceled and all claims related to the insurance policy have been settled. The interest income earned by these restricted deposit accounts is the property of the customer, and is therefore excluded from the Company's operating results.
9. REINSURANCE ASSUMED AND CEDED
The Company accounts for reinsurance assumed and ceded in accordance with SFAS 113 "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts". Net premiums earned are the result of the following:
The Company, in the ordinary course of business, reinsures certain risks with other companies. Such arrangements serve to enhance the Company's capacity to write business and limit the Company's maximum loss on large or more hazardous classes of risks.
Reinsurance contracts do not relieve the Company of its obligations to policyholders. Failure of reinsurers to honor their obligations could result in losses to the Company; consequently, allowances are established for amounts deemed uncollectible. The Company evaluates the financial condition of its reinsurers and monitors concentrations of credit risk to minimize its exposure to significant losses from reinsurer insolvencies. The Company has experienced substantial delays in collection of reinsurance recoverables from certain of its reinsurers. Realm National, a subsidiary of the Company, has commenced arbitration against two of these reinsurers. Management believes that approximately $9,342 and $10,537 of paid and outstanding losses recoverable from reinsurers for 2000 and 2001 respectively may prove uncollectible and has established a provision for doubtful recoveries accordingly. This provision of $9,342 for 2000 and $10,537 for 2001 against reinsurance recoveries of $34,964 in 2000 and $34,281 in 2001 represents management's best estimate at this time of a shortfall in recoveries. This provision is included in the balance sheet as an offset against paid and outstanding losses recoverable from reinsurers. The provision is an estimate and amounts not collectible from reinsurers may ultimately be significantly greater or less than the provision established. It is possible that management will revise this estimate in the future. Any subsequent differences arising will be recorded in the period in which they occur.
At December 31, 2000 there were amounts due from seven reinsurers that totaled $82,383, each in excess of 10% of the Company's shareholders' equity. At December 31, 2001 there were amounts due from twelve reinsurers that totaled $100,521, each in excess of 10% of the Company's shareholders' equity. These reinsurers are rated `Superior' by A.M. Best.
The Company recognizes reinsurance recoveries when the associated loss is booked.
Realm National is a property and casualty insurance company, and writes principally workers compensation, commercial fire, allied lines, and general liability.
Realm National ceded business to reinsurance companies for the following programs:
With respect to 1999 and prior years, one of the programs was subject to quota share reinsurance whereby Realm National retained 25% of the first $1,000 on any one risk and purchased excess of loss per occurrence reinsurance for limits above $1,000. A portion of Realm National's retention under its quota share treaties was further protected through the use of excess coverage that reduced Realm National's net retention to under $20 on any one risk. In addition, Realm National purchased excess of loss reinsurance above the quota share treaty with limits of at least $100,000. For the year 2000, Realm National purchased excess of loss reinsurance above $250. The excess of Loss limit was $50,000. In addition, Realm National purchased an 80% quota share reinsurance cover to further protect the $250 net retention that reduced Realm National's net retention to $50. In 2001, Realm National purchased excess of loss reinsurance above $250. The excess of loss limit was $50,000.
With respect to its other main workers' compensation program for 1998 and prior, the business was subject to quota share reinsurance whereby Realm National retained 25% of the first $1,000 on any one risk and purchased excess of loss per occurrence reinsurance for limits above $1,000. A portion of Realm National's retention under its quota share treaties was further protected by excess coverage that reduced Realm National's net retention to under $3 on any one risk. In addition, Realm National purchased excess of loss reinsurance above the quota share treaty with limits of $100,000 or higher. For the years 1999 and 2000 Realm National purchased excess of loss reinsurance above $1,000 up to limits of $50,000. In addition, Realm National purchased a 75% reinsurance cover to further protect part of the $1,000 net retention. This business was substantially reduced in 2001 as it was put into runoff. Catastrophy coverage in excess of $1,000 was purchased.
Realm National writes property business and purchased a property reinsurance program related to 2000 and prior years whereby it retained 25% of the first $1,000 on any one risk and purchased facultative reinsurance for limits above $1,000. In addition, Realm National's net retention was further protected with excess catastrophe limits to $10,000.
With respect to its general liability risks prior to 2000, Realm National purchased a reinsurance program whereby it retained 25% of the first $300 on any one risk and purchased facultative per-risk excess reinsurance for limits above $300. In 2000 and 2001, Realm National retained the first $300 for any one loss and purchased an excess-of-loss treaty providing limits of $700 excess of $300.
Due to the diminished availability of cost-effective reinsurance during 2000 and 2001, Realm National decreased the level of reinsurance it purchased on its programs, resulting in a greater retention of premium but also a greater exposure to the underwriting risk on those programs. Further, the events of September 11, 2001, have prompted reinsurers to restrict terms under their agreements, as they are no longer willing to provide automatic coverage for exposure of loss caused by acts of terrorism. Beginning in 2002, most reinsurance agreements now contain a specific exclusion for terrorism coverage. Simultaneously, two states (including New York, from which Realm National derives most of its business) have precluded primary insurance companies from exclusion of terrorism risk. As such, primary companies in those states are forced to carry the exposure alone. While the United States Federal Government and emerging reinsurance markets are exploring and introducing options for potential relief, management has adopted new guidelines in underwriting in an effort to measure and mitigate its exposure to loss.
Comp Indemnity Reinsurance Company Limited ("CIRCL"), a subsidiary of the Company, assumed various quota share reinsurance of workers' compensation and employers' liability on both a primary and excess basis. CIRCL's exposure under the reinsurance contracts assumed is limited in most instances to between $25 to $300 for workers' compensation and $1,000 per occurrence for employers' liability and in some instances is subject to an annual aggregate limit based on various percentages of original gross written premium income. CIRCL further limited its exposure through the purchase of reinsurance protection for certain risks covering losses in excess of $1 to $3 for workers' compensation and $50 per occurrence for employers' liability.
CIRCL also assumed bodily injury, difference in conditions, and property risks through a general liability treaty covering risks in the construction industry. CIRCL's exposure under the reinsurance contracts assumed is limited in most instances to $250 per occurrence. In most instances, CIRCL further limited this exposure through the purchase of reinsurance covering losses in excess of $63 per occurrence. In addition, CIRCL purchased aggregate reinsurance with limits based on various percentages of original gross written premium income.
Management decided in early 1999 to cease underwriting any new programs in CIRCL due to unfavourable results, and a number of existing contracts were not renewed for the 1999 year. In early 2001, following a review of its operations, the Company decided to completely discontinue its reinsurance segment, as discussed in Note 3.
10. OUTSTANDING LOSSES AND LOSS EXPENSES
Outstanding losses and loss expenses relate to the insurance and reinsurance activities of Realm National and CIRCL.
The changes in outstanding losses and loss expenses are summarized as follows:
The adverse development during 2000 and 2001 on prior years in continuing operations primarily reflects the strengthening of loss reserves at the Company's U.S.-based insurance carrier relating primarily to two programs terminated in 2000.
The adverse development during 1999, 2000 and 2001 on prior years in discontinued operations primarily reflects the increase in provisions for doubtful reinsurance recoveries of 2.1 million in 1999, $2.4 million in 2000 and $1.0 million in 2001, as discussed in Note 9, as well as an increase in claims frequency on one particular program that covers bodily injury and property risks in the construction industry.
11. SHARE CAPITAL AND ADDITIONAL PAID IN CAPITAL
The Company's authorized share capital at December 31, 2000 and 2001 comprised 20,000,000 ordinary shares of par value $0.25 each, of which 9,963,372 ordinary shares were issued and fully paid at December 31, 2000 and 2001. Outstanding shares at December 31, 2000 and 2001 were 9,519,972 and 9,519,972, respectively, which were net of 443,400 treasury shares at each date.
In December 1997, under a put and call option originally granted in April 1997, the Company purchased 40,000 ordinary shares for a total cost of $667. These shares were held as treasury stock at December 31, 2000 and 2001.
In October 1998, the Company purchased a further 47,000 of its ordinary shares on the open market for a total cost of $567. These shares were held as treasury stock at cost at December 31, 2000 and 2001.
In the first quarter of 1999, the Company purchased a further 356,400 of its ordinary shares on the open market for a total cost of $4,423. These shares were held as treasury stock at cost at December 31, 2000 and 2001.
Effective November, 2000, the Company issued 100,000 restricted shares to Mr. Stephen A. Crane. The shares issued are subject to certain transfer restrictions which lapsed with respect to 33 1/3% of these shares on the date of their issuance and 33 1/3% of these shares in November 2001. Restrictions on the balance of the shares lapse in November 2002, contingent on Mr. Crane's continued employment with the Company.
12. STOCK OPTIONS
Employees and directors have been granted options to purchase Ordinary Shares in the Company. These options have been issued as follows:
On November 25, 1997 the Company granted 300,000 options to certain employees. The options have an exercise price of $22 per share, which reflected the estimated fair value of the shares at the grant date. The options vest ratably over a three-year period and may be exercised at any time prior to November 25, 2007. At December 31, 2000 and 2001, 140,850 and 94,800 of these options remained outstanding. The balance of the options were forfeited.
On October 26, 1999 the Company granted 285,000 options to certain officers and directors. The options have an exercise price of $2.31 per share, which reflected the market price of the shares on that date. The options vest ratably over a three-year period and may be exercised at any time prior to October 26, 2009. All of these options were outstanding at December 31, 2001.
On March 7, 2000, the Company granted 25,000 options to an officer. The options have an exercise price of $3.25 per share, which reflected the estimated fair value of the shares at the grant date. The options vest ratably over a three-year period and may be exercised at any time prior to March 7, 2010. All of these options were outstanding at December 31, 2001.
On May 25, 2000, the Company granted 30,000 options to certain non-executive directors. The options have an exercise price of $2.50 per share, which reflected the estimated fair value of the shares at the grant date. The options vest ratably over a three-year period and may be exercised at any time prior to August 8, 2010. All of these options were outstanding at December 31, 2001.
On August 8, 2000, the Company granted 357,500 options to certain employees. The options have an exercise price of $2.0625 per share, which reflected the estimated fair value of the shares at the grant date. The options vest ratably over a three-year period and may be exercised at any time prior to August 8, 2010. At December 31, 2000 and 2001, 337,500 and 312,500 of these options remained outstanding. The balance of the options were forfeited.
On January 16, 2001, the Company granted 10,000 options to certain employees. The options have an exercise price of $1.38 per share, which reflected the estimated fair value of the shares at the grant date. The options vest ratably over a three-year period and may be exercised at any time prior to January 16, 2011. All of these options were outstanding at December 31, 2001.
On May 7, 2001 the Company granted 57,500 options to certain employees. The options have an exercise price of $1.42 per share, which reflected the estimated fair value of the shares at the grant date. The options vest ratably over a three-year period and may be exercised at any time prior to May 7, 2011. All of these options were outstanding at December 31, 2001.
On August 7, 2001, the Company granted 10,000 options to certain employees. The options have an exercise price of $2.00 per share, which reflected the estimated fair value of the shares at the grant date. The options vest ratably over a three-year period and may be exercised at any time prior to August 7, 2011. All of these options were outstanding at December 31, 2001.
In accordance with the provisions of FASB Statement No. 123, the Company applies APB Opinion 25 and related interpretations in accounting for its stock option plans and, accordingly, recognizes compensation cost based on the intrinsic value of the options at the grant date. If the Company had elected to recognize compensation cost based on the fair value of the options granted at the grant date, as prescribed by SFAS 123, net loss and loss per share would have been adjusted to the pro forma amounts indicated in the table below:
These pro forma compensation costs may not be representative of those to be expected in future years due to the timing of option issuances and pro-ration of the corresponding compensation costs.
The weighted average fair value of each option grant is estimated on the date of the grant using the Black-Scholes option pricing model, with the following assumptions used:
1999 2000 2001 ---- ---- ---- Expected dividend yield.......... 4.5% 3.7-5.8% 0% Expected stock price volatility.. 87.46% 92% 90% Risk-free interest rate.......... 6.72% 6.07-6.64% 5.35-5.39% Expected life of options......... 10 years 10 years 10 years
The weighted average fair value of options granted during 2001 was $1.38 per share. The weighted average fair value of options granted during 2000 was $1.09 per share. The fair value of options granted during 1999 was $1.25 per share.
13. TAXATION
Under current Bermuda law, the Company is not required to pay any taxes in Bermuda on either income or capital gains. The Company has received an undertaking from the Minister of Finance in Bermuda that, in the event of any such taxes being imposed the Company will be exempted from taxation until the year 2016.
Total income tax benefit attributable to income from continuing operations for the years ended December 31, 1999, 2000 and 2001 was allocated as follows:
Income tax benefit attributable to income from continuing operations consists of:
Income tax benefit attributable to loss from continuing operations and change in accounting method was ($2,771), ($2,523) and ($1,268) for the years ended December 31, 1999, 2000 and 2001 respectively, and differed from the amounts computed by applying the U.S. federal income tax rate of 34% and U.S. state tax at an effective rate of 2.64% to income before taxation as a result of the following:
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2000 and 2001 are presented below:
A valuation allowance of $2,624 has been recorded as of December 31, 2001 ($1,800 at December 31, 2000) against the tax effect of losses in connection with the Company's U.K. operations. With respect to U.S. taxation, a valuation allowance of $3,127 has been recorded as of December 31, 2001, ($Nil at December 31, 2000) against the value of net operating loss carryforwards, as management believes that portions of the net operating loss carryforwards may not be utilized within the next five years. U.S. federal and state tax loss carryforwards in the amount of approximately $11,000 are available to offset future U.S. federal and state taxable income. The federal net operating loss carryforwards are scheduled to expire in 2020 and 2021.
As of December 31, 1999 the Company had not recognized a deferred tax liability for the undistributed earnings of its United States subsidiaries. (A 30% tax is generally imposed in the United States on dividends paid by United States corporations to non-United States shareholders). As of December 31, 2000 and 2001 the Company had no undistributed earnings of its U.S. subsidiaries on a consolidated basis. The deferred tax liability relating to these unremitted earnings, which is not recognized by the Company, is approximately $2,442, $Nil and $Nil at December 31, 1999, 2000, and 2001, respectively.
14. EARNINGS PER SHARE
Earnings per share have been calculated in accordance with SFAS 128:
Potential shares that are issued during a year are normally considered as outstanding throughout the year for purposes of calculating net income (loss) per share assuming dilution unless a net loss is incurred, in which case the shares are considered anti-dilutive and are therefore excluded from the calculation. Due to losses in both continuing operations and total operations during 2000 and 2001, the anti-dilutive effect of the restricted share issuance described in Note 11 is excluded from the calculation of net loss per share assuming dilution.
See Notes 11 and 12 to the consolidated financial statements for further discussion of share capital and share option transactions.
15. FINANCIAL INSTRUMENTS
a) Fair value
The carrying values of all financial instruments, as defined by SFAS 107 and as recorded in the consolidated balance sheets, approximate their fair value. The Company does not have any significant off-balance-sheet financial instruments. The following methods and assumptions were used by the Company in estimating fair values:
Cash and cash equivalents and fiduciary funds: The carrying values for cash and cash equivalents and fiduciary funds approximated fair market values due to the short-term maturities of these instruments.
Marketable securities: The fair values of debt and equity securities are based on quoted market prices and dealer quotes at the consolidated balance sheet dates.
Deposit liabilities and related assets: Underlying assets are comprised mainly of cash and deposits. The carrying values for deposit liabilities and related assets approximated fair market values due to the short-term maturities of these instruments.
Other assets and liabilities: The fair values of all other financial instruments, as defined by SFAS 107, approximate their carrying values due to their short-term nature.
The estimates of fair values presented herein are subjective in nature and are not necessarily indicative of the amounts that the Company would actually realize in a current market exchange. Any differences would not be expected to be material. Certain amounts such as prepaid expenses, other assets, goodwill and deferred expenses, deferred fee income, outstanding losses recoverable from reinsurers, and outstanding losses and loss expenses are excluded from fair value disclosure. Thus the total fair value amounts cannot be aggregated to determine the underlying economic value of the Company.
b) Concentrations of credit risk and provision for doubtful accounts
The Company's financial instruments exposed to possible concentrations of credit risk consist primarily of its cash and cash equivalents, outstanding losses recoverable from reinsurers and insurance and reinsurance balances receivable.
The Company maintains a substantial portion of its cash and cash equivalents in two financial institutions that the Company considers of high credit quality.
Concentrations of credit risk with respect to other financial instruments are to some extent limited due to the number of reinsurers, agents and customers comprising the Company's receivable base. At December 31, 2000 there were amounts due from seven reinsurers that totaled $82,383, and at December 31, 2001 there were amounts due from twelve reinsurers that totaled $100,521, as discussed in Note 9. At December 31, 2000 and 2001, management believes that approximately $9,342 and $10,537 of paid and outstanding losses recoverable from reinsurers may prove uncollectible and has established a provision for doubtful accounts accordingly, as discussed in Note 9.
c) Forward foreign exchange contracts
The Company's functional currency is the U.S. dollar; however, as the Company operates internationally, it has exposure to changes in foreign currency exchange rates. These exposures include net cash inflows on non-U.S. dollar-denominated transactions.
To manage the Company's exposure to these risks, the Company enters into forward foreign exchange contracts in the currencies to which the Company is exposed. These contracts generally involve the exchange of one currency for another at some future date. The Company had one notional principal amount outstanding at December 31, 2000, relating to contracts to buy British Pounds Sterling in the future. This contract had a cost of $2,305, a fair value of $2,230, and an unrealized net loss of $70. The Company had no notional principal amounts outstanding at December 31, 2001 relating to contracts to buy British Pounds Sterling in the future. Net realized gains (losses) of $Nil, ($132) and $Nil have been recorded in the consolidated statements of income in respect of such contracts during the years ended December 31, 1999, 2000 and 2001, respectively.
16. SEGMENTAL INFORMATION
(a) The Company has three continuing business segments; Insurance, Program Business, and Brokerage. The insurance segment represents a subsidiary that underwrites and retains, subject to its own reinsurance, certain insurance and reinsurance risks, and its revenues include premiums earned on insurance polices, investment income and policy issuance fees. The program business segment comprises subsidiaries that market insurance products and manage programs developed by the Company. The brokerage segment comprises subsidiaries that receive a fee or commission for brokering insurance and reinsurance contracts. Other includes the Company's holding companies and group services companies. In early 2001, following a review of its operations, the Company decided to discontinue its reinsurance and underwriting management segments, as discussed in Note 3. Intercompany transactions are recorded under normal terms of trade. Adjustments and eliminations to revenue are in respect of intersegmental revenues that are eliminated at the consolidated level. Adjustments and eliminations of assets are primarily in respect of intersegmental insurance balances receivable that are eliminated at the consolidated level.
(b) Summarized financial information by geographic location of subsidiary for the years ended December 31, 1999, 2000 and 2001, is as follows:
(c) The Company's Program Business subsidiaries market and manage insurance products and programs developed by the Company on behalf of independent insurance carriers. In addition, the Company, through its brokerage operations, provides additional business and services to certain of these independent insurance carriers in respect of these products and other insurance and reinsurance policies. For the years ended December 31, 1999, 2000 and 2001 revenues received from one independent insurance carrier accounted for approximately the following percentage of total revenues.
December 31, 1999 2000 2001 ---- ---- ---- CONTINUING OPERATIONS: Insurance 0% 17% 25% Program business 70% 74% 92% Brokerage 19% 14% 11% Other 0% 0% 0% -- -- -- Total for continuing operations 34% 33% 37%
DISCONTINUED OPERATIONS: Underwriting management 91% 100% 62% Reinsurance 72% 74% 0% --- --- -- Total for Discontinued 83% 85% 73% operations --- --- --- Total for all operations 39% 37% 37%
The loss of this carrier could have a material adverse effect on the Company. However, the Company believes that, subject to market conditions, the availability of alternative underwriting capacity at Realm National and other independent insurance carriers would reduce the impact of such a loss.
17. COMMITMENTS
Future minimum lease payments under non-cancelable operating property leases as at December 31, 2001 are as follows:
2002.................. $ 2,023 2003.................. 1,795 2004.................. 1,549 2005.................. 1,060 2006.................. 949 2007 and thereafter... 2,519 ------- $ 9,895
Total rental expense for continuing operations for the years ended December 31, 1999, 2000 and 2001, was $3,089, $1,854, and $2,175, respectively. Total rental expense for discontinued operations for the years ended December 31, 1999, 2000 and 2001, was $114, $117, and $120, respectively.
Certain lease commitments are subject to annual adjustment, under escalation clauses, for real estate taxes and the landlord's operating expenses. Such adjustments will not be material to the Company.
18. STATUTORY SURPLUS AND DIVIDEND RESTRICTIONS
The Company's ability to pay dividends is subject to certain restrictions, including the following:
a) The Company is subject to a 30% withholding tax on certain dividends and interest received from its United States subsidiaries.
b) Under New York law, Realm National may pay cash dividends only from earned surplus determined on a statutory basis. Further, Realm National is restricted (on the basis of the lower of 10% of statutory surplus at the end of the preceding twelve-month period, or 100% of the adjusted net investment income for the preceding twelve-month period) as to the amount of dividends it may declare or pay in any twelve- month period without the approval of the Insurance Department of the State of New York.
No dividends were declared or paid from 1999 to 2001 due to its statutory basis accumulated deficit.
Realm National's total capital and surplus and net income determined on a New York statutory basis are as follows:
2000 2001 ---- ---- Total capital and surplus at December 31,....... $14,116 $13,840 Net income (loss) for year ended December 31,... $(4,167) $(4,558)
New York insurance law does not allow deferred tax assets to be carried as an admitted asset and included in statutory surplus. NAIC rules do allow the asset to be included in statutory surplus. Total capital and surplus was $14,699 at December 31, 2001 on the NAIC basis.
c) The NAIC has a model law which establishes certain minimum risk-based capital ("RBC") requirements for property-casualty insurance companies. The RBC calculation serves as a benchmark for the regulation of insurance companies by state insurance regulators. The Authorized Control Level RBC is equal to 200% of the RBC requirement. Realm National total Adjusted Capital at December 31, 2001 was $13,840, compared to the Authorized Control Level RBC requirement of $5,265.
d) The Company's Bermuda reinsurance subsidiary, CIRCL, is required by its license to maintain capital and surplus greater than a minimum statutory amount determined as the greatest of $1,000, a percentage of outstanding losses and loss expenses (net of reinsurance recoverable) or a given fraction of net written premiums. At December 31, 2000 and 2001, respectively, CIRCL was required to maintain a minimum statutory capital and surplus of $1,272 and $1,000. CIRCL is currently unable to meet this minimum statutory requirement.
CIRCL's total surplus (deficit) and net loss determined on a Bermuda statutory basis is as follows:
2000 2001 ------ ------ Total surplus (deficit) at December 31....... $ 752 $(4,333) Net loss for year ended December 31.......... $(5,641) $(5,678)
CIRCL is also required to maintain a minimum liquidity ratio whereby the value of its relevant assets is not less than 75% of the amount of its relevant liabilities. Certain categories of assets do not qualify as relevant assets under the statute. At December 31, 2000 and 2001, respectively, CIRCL was required to maintain relevant assets of at least $17,234 and $5,808. At those dates relevant assets were approximately $23,718 and $3,370 and the minimum liquidity ratio was therefore not met at December 31, 2001.
Increases in loss reserves caused CIRCL's shareholder equity to become negative in the third quarter of 2001, and CIRCL is therefore insolvent and remained insolvent at December 31, 2001. Additionally, as CIRCL has not met its two key statutory requirements, management of CIRCL have been in contact wtih the Regulators to fully apprise them of current and intended action. Detailed discussions have also been held with CIRCL's principal creditors regarding the insolvency and the various alternatives of action that may be taken. It is the Company's intention not to provide additional funds to CIRCL for losses it has incurred. CIRCL's insolvency, therefore, will not have a material effect on the consolidated financial position of the Company.
19. RELATED PARTY TRANSACTIONS
Goldman, Sachs & Co. or certain of its affiliates maintained certain contractual relationships with the Company and provided investment banking services to the Company. Goldman, Sachs & Co. also provided investment management services to Realm National until December 31, 2000, pursuant to a Corporate Account Agreement dated December 24, 1996 and received customary fees and expenses of approximately $35 during 2000 and $Nil during 2001 for such services.
20. CONTINGENCIES
(a) The trial in the proceedings which Sphere Drake Insurance Limited ("Sphere Drake") caused to be issued on February 29, 2000 in the London Commercial Court (equivalent to a civil complaint in U.S. jurisdictions) against two of the Company's U.K. subsidiaries, two former officers of those subsidiaries and others, is underway and currently is expected to conclude during the second quarter of 2002. Sphere Drake alleges, in substance, that each and every contract placed with it through its underwriting agent by the Company's U.K. broker subsidiary was commercially unreasonable. Sphere Drake further alleges that this was obvious to the broker and that, accordingly, the London Commercial Court should infer a conspiracy between the broker and the underwriting agent to defraud Sphere Drake, thereby allowing it to treat as void from the outset all of the inwards reinsurance contracts placed with Sphere Drake through its underwriting agent by the Company's broker subsidiary.
It is the opinion of management that the claims described in Sphere Drake's action are without merit and the case is being and will be defended vigorously.
(b) On December 6, 2001, the jury returned a verdict dismissing all of the claims asserted against the Company, together with one of its London subsidiaries and a former employee of that subsidiary, in a third party action in the New York State Supreme Court brought by AXA Reassurance S.A. ("AXA"). The verdict also encompassed all of the claims asserted against these same defendants by New Hampshire Insurance Company ("NHIC"). In that action, AXA had sought indemnity and damages resulting from its efforts to void reinsurance contracts entered into in connection with certain "reinsurance-backed gap film financing" arrangements ("Film Finance Covers") brokered by the Company's London subsidiary. Certain claims in the action relating to other parties remain to be resolved by the Court, with the result that a final judgment subject to appeal has not yet been entered.
On July 2, 2001, the third-party complaint filed by defendant AXA Corporate Solutions (U.K.) Ltd. ("ACS") against the Company, one of its London subsidiaries and a former employee of that subsidiary (the "SCB Defendants") in an existing action originally brought by the insured Silicon Valley Bank was dismissed without prejudice. The third party complaint had alleged fraudulent and/or wrongful inducement to contract allegedly resulting in exposure to liability for claims under another Film Finance Cover brokered by the Company's London subsidiary. ACS filed a motion seeking reconsideration of that decision, which motion was denied by the Court on March 18, 2002. Two of the Company's London subsidiaries were served with a separate third-party complaint in this action alleging claims for fraudulent inducement, negligent misrepresentation and fraud and deceit by a different insurer defendant, NHIC. The London subsidiaries have entered into a tolling agreement with NHIC that will suspend for the time being the prosecution of NHIC's claims as well as the running of the statute of limitations pertaining thereto.
Two of the Company's London subsidiaries have been named as third party defendants in a federal court action instituted by Silicon Valley Bank in California involving a different Film Finance Cover. These subsidiaries also were named as defendants in a federal district court action by NHIC, which action has been dismissed without prejudice. The tolling agreement referred to above also applies to these claims.
Two of the Company's London subsidiaries, together with other unrelated parties, have been named as third-party defendants in an existing action in the New York State Supreme Court, filed on March 16, 2001 by NHIC. Each pleading alleges identical claims of fraudulent inducement and negligent misrepresentation against two of the Company's London subsidiaries in connection with another Film Finance Cover. A motion to dismiss has been made and is awaiting decision by the court.
It is the opinion of management that the claims described in these actions are without merit and the cases are being and will be defended vigorously.
Certain of the Company's subsidiaries acted as brokers in connection with other Film Finance Covers which either have become the subject of inquiry by one or more of the parties involved therein, or which have given rise to disputes not directly involving the Company or its subsidiaries. Although no assurances can be given as to the outcome of these disputes or of other potential proceedings related to the Film Finance Covers and their effect on the Company, the Company believes, based on the information presently available to it, that any such effect should not have a material adverse effect on the Company's financial condition.
(c) Several arbitration proceedings currently are pending in England between reinsurers and ceding insurers relating to reinsurance transactions involving the personal accident excess of loss market in London ("LMX") for the account years 1993, 1994, 1995, 1996, 1997 and 1998. Although neither the Company nor any of its broker subsidiaries is a party to any of these arbitrations, certain of the Company's subsidiaries acted as a reinsurance broker for ceding insurer clients that are parties to certain of the arbitrations.
In addition, the Company's reinsurance subsidiary is party to one of the LMX arbitrations. This particular arbitration has been dormant for some time.
The reinsurers generally have alleged that they sustained losses due to an "artificial" spiral in the LMX market, the existence of which, as well as other information, was not disclosed to them by the ceding insurers or their reinsurance brokers. In others, there are specific misrepresentation and non-disclosure allegations that are not of a generic nature. As a consequence, these reinsurers have asserted that they are no longer obliged to honor their reinsurance agreements and have suspended payment of claims.
During 1998 and 1999 certain of the reinsurers and reinsureds that are parties to the arbitrations described above issued proceedings in the English courts against one or more of the Company's brokerage subsidiaries and one underwriting management subsidiary, apparently for the primary purpose of tolling the statute of limitations pending the outcome of the arbitrations. In one proceeding against the same subsidiaries, three former officers of the subsidiaries were also named. In none of these proceedings did the complainant specify an amount of damages sought. If one or more reinsurers succeed in avoiding its contracts in the pending arbitrations, it is possible that ceding insurer clients, on whose behalf the Company's broker subsidiaries placed the reinsurance, may seek to pursue a claim for indemnification or other claims against one or more of those subsidiaries. Similarly, if one or more of the reinsurers fail to avoid its contracts in the pending arbitrations, it also is possible that those reinsurers may seek to pursue some type of claim against one or more of those subsidiaries.
The Company understands that awards already have been made in favor of the reinsurer in two arbitrations. However, based on the Company's understanding of the reasons given by the arbitration panels for their awards in favor of the reinsurer in two of those cases, the Company does not believe there is any valid basis for its ceding insurer clients in those cases to assert a claim against the Company or its broker subsidiaries. The Company has insufficient information to make a valid assessment in relation to the third.
With the exception of: (a) one inactive proceeding which the subsidiaries have been informed will be withdrawn; and (b) two related proceedings pending against certain subsidiaries of the Company, and certain current and former officers of these subsidiaries, each of which is in an early procedural stage, all judicial proceedings against the Company's subsidiaries relating to these matters have been stayed or held in abeyance pursuant to standstill agreements or court order.
One of the arbitration awards referenced above allowed a reinsurer to avoid certain of its reinsurance contracts with a Lloyd's syndicate. According to reports in the London press, that award may have caused the syndicate's liabilities to increase beyond the financial resources available to it and its Names, requiring the syndicate to avail itself of the Lloyd's Central Fund. Thereafter, Lloyd's initiated an investigation of that syndicate and all "market participants," including the Company's U.K. subsidiaries. The Company is aware that the investigation is ongoing, but has no other information as to the progress of the investigation or when it will be completed.
The Company understands that substantial progress has been and continues to be made by various market participants in settling ongoing reinsurance disputes, including many of the market participants that are parties to the arbitrations and other proceedings described above. The Company understands that a settlement by certain market participants of reinsurance disputes arising in the 1994 year of account (the "1994 Year of Account Settlement") has been executed. The Company further understands that working groups have been established to attempt to arrive at similar settlements in respect of the 1995 and 1996 years of account.
A subsidiary of the Company has been notified of a potential claim by one of the parties to the 1994 Year of Account Settlement for the recovery of costs arising out of the settlement as well as for the costs and expenses incurred by the party in connection with its overall involvement in the LMX market. The subsidiary has denied any liability for this potential claim.
Although no assurances can be given as to the outcome of the pending U.K. arbitrations or pending or potential arbitration or judicial proceedings related to the LMX spiral reinsurance arbitrations and their effect on the Company, the Company believes, based on the information presently available to it, that any such effect should not have a material adverse effect on the Company's financial condition.
(d) Beginning in late 1998 and 1999, the reinsurance markets in which the Company historically has been involved experienced considerable disruption for a variety of reasons, including but not limited to the LMX market disputes described above and other disputes involving the North American workers' compensation reinsurance market. The effects of this disruption have continued up to the present time.
One result of this market disruption has been that certain reinsurers with whom the Company's broker subsidiaries placed business on behalf of ceding insurer clients suspended claims payments to those clients, as well as to the Company's insurance and reinsurance subsidiaries, in certain instances also claiming a right to rescind the reinsurance contracts. As a result, a number of arbitrations were commenced between Company clients and their reinsurers. The Company has endeavored consistently to provide support to its clients in connection with these proceedings. In one ongoing arbitration involving the Company's insurer subsidiary, Realm National, that company has succeeded in obtaining $4.8 million in interim relief from a reinsurer by order of the arbitration panel pending a final determination of the matters in issue, which is expected in the second quarter of the year.
In some instances, disputes or potential disputes have arisen concerning whether reinsurance was properly placed by the Company's broker subsidiaries. In other instances, the Company's ceding insurer clients have demanded indemnification by the Company if the client's reinsurance contracts ultimately are avoided by its reinsurers.
Although no assurances can be given as to the effect on the Company of the various disputes in the worker's compensation reinsurance market, or related arbitrations, the Company believes, based on the information presently available to it, that any such effect should not have a material adverse effect on the Company's financial condition.
(e) The Company is subject to other litigation and arbitration in the ordinary course of its business. While any of these proceedings contains an element of uncertainty, management presently believes the outcome of these currently pending proceedings will not have a material adverse effect on the Company's financial condition.
21. QUARTERLY FINANCIAL DATA--UNAUDITED
ITEM 9
ITEM 9 - -CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10
ITEM 10 - -DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Certain of the information required by this item is included in Part 1 of this Form 10-K.
The remainder of this item is omitted because the information will be contained in a definitive proxy statement, which involves the election of directors, to be filed with the Securities and Exchange Commission not later than 120 days after December 31, 2001. Such information is hereby incorporated by reference.
ITEM 11
ITEM 11 - -EXECUTIVE COMPENSATION
This item is omitted because the information will be contained in a definitive proxy statement, which involves the election of directors, to be filed with the Securities and Exchange Commission not later than 120 days after December 31, 2001. Such information is hereby incorporated by reference.
ITEM 12
ITEM 12 - -SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
This item is omitted because the information will be contained in a definitive proxy statement, which involves the election of directors, to be filed with the Securities and Exchange Commission not later than 120 days after December 31, 2001. Such information is hereby incorporated by reference.
ITEM 13
ITEM 13 - -CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Certain of the information required by this item is included in Part 2, Item 8 of this Form 10-K.
The remainder of this item is omitted because the information will be contained in a definitive proxy statement, which involves the election of directors, to be filed with the Securities and Exchange Commission not later than 120 days after December 31, 2001. Such information is hereby incorporated by reference.
PART IV
ITEM 14
ITEM 14 - -EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(A) EXHIBITS
EXHIBIT NO. DESCRIPTION - --------------------- -----------------------------------------------------
3.l Memorandum of Association of the Company (1)
3.2 Bye-Laws of the Company (1)
4.1 Shareholders' Agreement, dated as of January 24, 1996, among the Management Shareholders (as defined therein), Bridge Street Fund 1995, L.P., Goldman Sachs & Co. Verwaltungs GmbH (for GS Capital Partners II German Civil Law Partnership), GS Capital Partners II, L.P., GS Capital Partners Offshore, L.P., Stone Street Fund 1995, L.P. and the Company (1)
4.2 Registration Rights Agreement, dated January 24, 1996, between the Company, the Management Shareholders (as defined therein) and the Investors (as defined therein) (1)
10.1 Stirling Cooke Brown Holdings Limited 1997 Equity Incentive Plan (1)*
10.2 Employment Agreement dated September 1, 1997 between Realm Investments Ltd. and Nicholas Mark Cooke (1)*
10.4 Employment Agreement dated September 1, 1997 between Stirling Cooke Brown Holdings Limited and George W. Jones (l)*
10.5 Agency Agreement dated as of June 1, 1995 between Clarendon National Insurance Company and Stirling Cooke Insurance Services, Inc. (1)
10.6 Amendment Number One to Agency Agreement dated as of June 1, 1995 between Clarendon National Insurance Company and Stirling Cooke Insurance Services, Inc. (1)
10.7 Amendment Number Two to Agency Agreement dated as of June 1, 1995 between Clarendon National Insurance Company and Stirling Cooke Insurance Services, Inc. (1)
10.8 Addendum dated April 1, 1997 to Agency Agreement dated as of June 1, 1995 between Clarendon National Insurance Company and Stirling Cooke Insurance Services, Inc. (1)
10.9 Agency Agreement dated as of October 1, 1995 between Clarendon National Insurance Company and Stirling Cooke Texas, Inc. (1)
11. Statement of Computation of Per Share Earnings
16. Letter of KPMG regarding change in certifying accountant (2)
21. Subsidiaries of the Company
99. Forward-Looking Information
99.1 Letter to Commission Pursuant to Temporary Note 3T
(1) Incorporated by reference from Registration Statement on Form S-1 (No. 333-32995) of Stirling Cooke Brown Holdings Limited.
(2) Incorporated by reference from the Company's form 8-K filed April 28, 1999.
*Management Compensation
(B) REPORTS ON FORM 8-K.
None.
(C) FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
1. Financial Statements
Included in Part II--Item 8 of this report.
2. Index to Financial Statement Schedules
Included in Part IV of this report:
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
The Board of Directors and Shareholders of Stirling Cooke Brown Holdings Limited
Under date of March 18, 2002, we reported on the consolidated balance sheets of Stirling Cooke Brown Holdings Limited and subsidiaries as of December 31, 2000 and 2001, and the related consolidated statements of income and comprehensive income, changes in shareholders' equity and cash flows for each of the three years in the period ended December 31, 2001. These consolidated financial statements referred to above are included in Item 8 of this Annual Report on Form 10-K for each of the three years in the period ended December 31, 2001. In connection with our audits of the three aforementioned consolidated financial statements, we also audited the related financial statement schedules listed in the accompanying index. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statement schedules based on our audits.
In our opinion, the amounts included in the financial statement schedules fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.
/s/ Arthur Andersen LLP
Arthur Andersen LLP New York, New York March 18, 2002
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED IN HAMILTON, BERMUDA, ON THE 28TH DAY OF MARCH, 2002.
STIRLING COOKE BROWN HOLDINGS LIMITED
/S/ STEPHEN A. CRANE By Stephen A. Crane Chief Executive Officer
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW AS OF THIS 28TH DAY OF MARCH, 2002, BY THE FOLLOWING PERSONS IN THE CAPACITIES INDICATED:
SIGNATURE TITLE - ------------------------------ -------------------------------------
/S/ STEPHEN A. CRANE President, Chief Executive Officer and Director (Principal Executive Officer) - - Stephen A. Crane
/S/ LEN QUICK Chief Operating Officer and Director
Len Quick
/S/ GEORGE W. JONES Director
George W. Jones
/S/ PATRICK J. MCDONOUGH Director
Patrick J. McDonough
/S/ DAVID H. ELLIOTT Director
David H. Elliott
/S/ HADLEY C. FORD Director
Hadley C. Ford
/S/ PETER S. CHRISTIE Director
Peter S. Christie
/S/ JEAN DE POURTALES Director
Jean de Pourtales