ITEM 1. BUSINESS
INTRODUCTION
Transatlantic Holdings, Inc. (the 'Company') is a holding company incorporated in the state of Delaware. Originally formed in 1986 under the name PREINCO Holdings, Inc. as a holding company for Putnam Reinsurance Company (Putnam), the Company's name was changed to Transatlantic Holdings, Inc. on April 18, 1990 following the acquisition on April 17, 1990 of all of the common stock of Transatlantic Reinsurance Company (TRC) in exchange for shares of common stock of the Company (the 'Share Exchange'). Prior to the Share Exchange, American International Group, Inc. (AIG) held a direct and indirect interest of approximately 25% in the Company and an indirect interest of 49.99% in TRC. As a result of the Share Exchange, AIG became the beneficial owner of approximately 41% of the Company's outstanding common stock and TRC became a wholly-owned subsidiary of the Company. In June 1990, certain stockholders of the Company (other than AIG) sold shares of the Company's common stock in a registered public offering, with the result that approximately 35% of the Company's outstanding common stock became publicly owned. Since that date, additional shares of the Company's common stock have become publicly owned as a result of sales by such stockholders. During 1998, AIG increased its 49% beneficial ownership of the Company's outstanding common stock to 52% as of year end. As of March 11, 1999, AIG's beneficial ownership interest increased to approximately 55% as a result of additional share purchases.
The Company, through its wholly-owned subsidiaries, TRC, Trans Re Zurich (TRZ), acquired by TRC in 1996 (See Note 1 of Notes to Consolidated Financial Statements), and Putnam (contributed by the Company to TRC in 1995), offers reinsurance capacity for a full range of property and casualty products on a treaty and facultative basis, directly and through brokers, to insurance and reinsurance companies, in both the domestic and international markets. One or both of TRC and Putnam is licensed, accredited, authorized or can serve as a reinsurer in 50 states, Puerto Rico, Guam and the District of Columbia in the United States. TRC is licensed by the federal government of and seven provinces in Canada. TRC is also licensed in Japan, the United Kingdom and the Dominican Republic and is registered or authorized as a foreign reinsurer in Peru, Colombia, Argentina (where it also maintains a representative office in Buenos Aires, Transatlantic Re (Argentina) S.A.), Brazil (where it maintains a representative office in Rio de Janeiro, Transatlantic Re (Brasil) Ltda.) Chile, Mexico, Ecuador, Guatemala, Venezuela and France. In addition, TRC is licensed in the Hong Kong Special Administrative Region, People's Republic of China, and maintains a branch in Hong Kong. Also, TRC is authorized to maintain a representative office in Shanghai, People's Republic of China. TRZ is licensed as a reinsurer in Switzerland. TRH's (Transatlantic Holdings, Inc. and its subsidiaries) principal lines of reinsurance include general liability (including directors' and officers' liability and other professional liability), automobile liability (including nonstandard risks), ocean marine and aviation, medical malpractice and surety and credit in the casualty lines, and fire and allied lines in the property lines. Reinsurance is provided for most major lines of insurance on both excess-of-loss and pro rata bases.
Each of TRC and Putnam is currently rated 'A++ (Superior)', the highest rating classification, by A.M. Best Company (Best's) and 'AA', the second highest major rating classification, by Standard and Poor's (S&P). TRC is also rated Aa1 ('Excellent'), the second highest rating classification, by Moody's Investors Service (Moody's) and TRZ is rated 'A' by S&P. Best's, S&P and Moody's are independent industry rating organizations. A publication of Best's indicates that the 'A++ (Superior)' rating is assigned to those companies that, in Best's opinion, have, on balance, superior financial strength, operating performance and market profile when compared to standards established by Best's and that have a very strong ability to meet their ongoing obligations to policyholders. A publication of S&P advises that companies that receive an insurer financial strength rating of 'AA' have very strong financial security characteristics differing only slightly from those rated higher, and that companies that receive a rating of 'A' have strong financial security characteristics but are somewhat more likely to be affected by adverse business conditions than are insurers with higher ratings. A publication of Moody's advises that an insurance financial strength rating of Aa1 is assigned to those ranked at the higher end
of insurance companies offering excellent financial security, but whose long-term risks appear somewhat larger than companies in the highest rating category. These ratings are based upon factors that may be of concern to policy or contract holders, but may not reflect the considerations applicable to an equity investment in an insurance or reinsurance company.
The statutory surplus of TRC of $1,343.7 million, as of December 31, 1998, ranked TRC as the 5th largest domestic reinsurer according to statistics distributed by the Reinsurance Association of America. Although TRC and its wholly-owned subsidiary, Putnam, are separate entities, together they would have ranked as the 4th largest domestic reinsurer based upon combined statutory net premiums written of $1,257.3 million and 5th based upon combined statutory net income of $208.9 million for the year ended December 31, 1998, according to such statistics.
THE REINSURANCE BUSINESS
Reinsurance is an arrangement whereby one or more insurance companies, the 'reinsurer,' agrees to indemnify another insurance company, the 'ceding company,' for all or part of the insurance risks underwritten by the ceding company. Reinsurance can provide certain basic benefits to the ceding company. It reduces net liability on individual risks, thereby enabling the ceding company to underwrite more business than its own resources can support; it provides catastrophe protection to lessen the impact of large or multiple losses; it stabilizes results by leveling fluctuations in the ceding company's loss ratio; and it helps the ceding company maintain acceptable surplus and reserve ratios.
There are two major classes of reinsurance: treaty reinsurance and facultative reinsurance. Treaty reinsurance is a contractual arrangement that provides for the automatic reinsuring of a type or category of risk underwritten by the ceding company. Facultative reinsurance is the reinsurance of individual risks. Rather than agreeing to reinsure all or a portion of a class of risk, the reinsurer separately rates and underwrites each risk. Facultative reinsurance is normally purchased to cover risks not covered by treaty reinsurance or for individual risks covered by reinsurance treaties that are in need of capacity beyond that provided by such treaties.
A ceding company's reinsurance program may involve pro rata and excess-of-loss reinsurance on both a treaty and facultative basis. Under pro rata reinsurance (also referred to as proportional), the ceding company and the reinsurer share the premiums as well as the losses and expenses in an agreed proportion. Under excess-of-loss reinsurance, the reinsurer agrees to reimburse the ceding company for all losses in excess of a predetermined amount up to a predetermined limit. Premiums paid by the ceding company to the reinsurer for excess-of-loss coverage are generally not proportional to the premiums that the ceding company receives because the reinsurer does not assume a proportionate risk.
In pro rata reinsurance, the reinsurer generally pays the ceding company a ceding commission. Generally, the ceding commission is based on the ceding company's cost of obtaining the business being reinsured (i.e., brokers' and agents' commissions, local taxes, settlement costs and administrative expenses). There is usually no ceding commission on excess-of-loss reinsurance and therefore the pricing mechanism used by reinsurers is a rate applicable to premiums of the individual policy or policies subject to the reinsurance agreement.
In general, casualty insurance protects the insured against financial loss arising out of its obligation to others for loss or damage to their person or property. Property insurance protects the insured against financial loss arising out of the loss of property or its use caused by an insured peril. Property and casualty reinsurance protects the ceding company against loss to the extent of the reinsurance coverage provided. A greater degree of unpredictability is generally associated with casualty risks and catastrophe-exposed property risks, and there tends to be a greater lag in the reporting and settlement of casualty reinsurance claims, due to the nature of casualty risks and their greater potential for litigation.
GENERAL
TRH reinsures risks from a broad spectrum of industries throughout the United States and foreign countries. A portion of the reinsurance written by TRH is assumed from AIG and its subsidiaries (the 'AIG Group') and therefore reflects their underwriting philosophy and diversified insurance products.
Approximately $167 million (11%), $181 million (12%) and $232 million (18%) of gross premiums written by TRH in the years 1998, 1997 and 1996, respectively, were attributable to reinsurance purchased by the AIG Group. (For a discussion of TRH's business with the AIG Group, see 'Relationship with the AIG Group.')
In 1998, TRH's activities in the United States were conducted through its worldwide headquarters in New York and its regional office in Chicago. All domestic treaty business is underwritten by, or under the close supervision of, senior officers of TRH located in New York. TRH's headquarters in New York, the Miami office (underwriting business from Latin America and the Caribbean) and international offices in Toronto, London, Paris, Zurich, Hong Kong and Tokyo can offer treaty as well as facultative reinsurance. In addition, TRH operates representative offices in Buenos Aires, Rio de Janeiro and Shanghai; the latter two offices opened in early 1998. In addition, in late 1998, TRH entered into an exclusive arrangement with a representative agency in Johannesburg, South Africa. Non-U.S. business (representing risks underwritten by the Miami office and the other international offices) accounted for approximately 49%, 48% and 40% of net premiums written in 1998, 1997 and 1996, respectively. (See Management's Discussion and Analysis of Financial Condition and Results of Operations (Management's Discussion) for a discussion of premium fluctuations between years and Note 13 of Notes to Consolidated Financial Statements for financial data by business segment.) In addition, London branch net premiums written in 1998 totaled $304.4 million, or 22% of worldwide net premiums written. (For a discussion of certain conditions associated with international business see 'Regulation' and Note 13 of Notes to Consolidated Financial Statements.)
Casualty reinsurance constitutes the larger portion of TRH's business, accounting for 71% of net premiums written in 1998 and 67% in 1997 and 1996. As a general matter, due to the longer period of time necessary to settle casualty claims, casualty reinsurance underwriting tends to involve variables (such as those discussed in the paragraph immediately following) that are not as predictable as those in property reinsurance underwriting. The greater degree of uncertainty associated with casualty business as a result of these variables may produce a more volatile result over a period of time, although property reinsurance, including property catastrophe business, is also subject to significant year to year volatility due to major natural disasters. TRH also seeks to focus on more complex risks within the casualty and property lines, and to adjust its mix of business to take advantage of market opportunities.
In general, the overall operating results (including investment performance) and other changes to stockholders' equity of property and casualty insurance and reinsurance companies, and TRH, in particular, are subject to significant fluctuations due to competition, catastrophic events, economic and social conditions, foreign currency rate fluctuations, interest rates and other factors, such as changes in tax laws, tort laws and the regulatory environment.
The following table presents certain underwriting information concerning TRH's casualty and property business for the periods indicated:(5)
- ------------ (1) A significant portion of this line includes more complex risks such as professional liability (other than medical malpractice), directors' and officers' liability, errors and omissions and environmental impairment liability.
(2) In 1998, development on reserves held at December 31, 1997 significantly decreased the loss ratios in general liability, medical malpractice and allied lines and significantly increased the loss ratios in ocean marine and aviation.
(3) In 1997, development on reserves held at December 31, 1996 significantly decreased the loss ratios in other casualty and other property lines and significantly increased the loss ratios in ocean marine and aviation, and the surety and credit area.
(4) In 1996, development on reserves held at December 31, 1995 significantly decreased the loss ratios in other casualty, allied lines and other property lines and significantly increased the loss ratio in surety and credit.
(5) See Management's Discussion and Analysis of Financial Condition and Results of Operations for a discussion of TRH's underwriting components.
Treaty reinsurance constitutes the larger portion of TRH's business, accounting for 95%, 94% and 90% of net premiums written in 1998, 1997 and 1996, respectively.
The following table presents certain information concerning TRH's treaty and facultative business for the periods indicated:
- ------------ (1) In 1998 compared to 1997, international treaty premiums increased in specialty casualty classes (particularly other professional liability, which is included in general liability), automobile physical damage, automobile liability and aircraft lines, and decreased in the fire line. Domestic treaty premiums increased in the automobile liability line (including nonstandard risks) and certain specialty casualty classes (particularly other professional liability and accident and health lines), and decreased in the medical malpractice line.
(2) In 1997 compared to 1996, international treaty premiums increased in automobile liability, automobile physical damage, fire and allied lines. The majority of these increases resulted from the inclusion of a full year of TRZ premiums in 1997 versus six months data reflected in 1996, following its acquisition in the third quarter of that year by TRH. Facultative business comprises a small portion of overall international premiums. Domestically, treaty premium decreases in general casualty, allied lines and automobile liability (including nonstandard risks) were partially offset by increases in homeowners multiple peril, aircraft and accident and health lines. Domestic facultative premiums declined in property and general casualty classes, partially offset by modest increases in specialty casualty classes.
TREATY REINSURANCE
Treaty reinsurance accounted for approximately $1,438.5 million of gross premiums written and $1,320.2 million of net premiums written in 1998, approximately 71% of which resulted from casualty lines treaties, with the remainder from property lines treaties. Approximately 64% of treaty gross premiums written in 1998 represented treaty reinsurance written on a pro rata basis and the balance represented treaty reinsurance written on an excess-of-loss basis. Approximately 7% of treaty gross premiums written in 1998 were attributable to the AIG Group. Such premiums were primarily written on a pro rata basis. The majority of TRH's non-AIG Group treaty premiums were also written on a pro rata basis. As pro rata business is a proportional sharing of premiums and losses among ceding company and reinsurer, generally, the underwriting results of such business more closely reflect the underwriting results of the business ceded than do the results of excess-of-loss business.
TRH's treaty business consists primarily of lines of business within general liability (including directors' and officers' liability and other professional liability), automobile liability (including nonstandard risks), ocean marine and aviation, medical malpractice, surety and credit, fire and allied lines. A significant portion of TRH's business within these lines (primarily general liability and medical malpractice) is derived from certain more complex risks. TRH also underwrites non-traditional reinsurance, which blends funding characteristics with more traditional risk transfer.
TRH's treaty underwriting process emphasizes a team approach between TRH's underwriters, actuaries and claims staff, as appropriate. Treaties are reviewed for compliance with TRH's underwriting guidelines and objectives and certain larger treaties are evaluated in part based upon actuarial analyses conducted by TRH. The generic actuarial models used in such analyses are tailored in each case to the exposures and experience underlying the specific treaty and the loss experience for the risks covered thereunder. TRH also at times conducts underwriting audits at the offices of a prospective ceding company before entering into major treaties, because reinsurers, including TRH, do not separately evaluate each of the individual risks assumed under their treaties and, consequently, are largely dependent on the original underwriting decisions made by the ceding company. Such
dependence subjects TRH and reinsurers in general to the possibility that the ceding companies have not adequately evaluated the risks to be reinsured and, therefore, that the premiums ceded in connection therewith may not adequately compensate the reinsurer for the risk assumed.
TRH offers brokers full service with large capacity for both casualty and property risks. For non-AIG business, TRH generally seeks to lead treaty arrangements. The lead reinsurer on a treaty generally accepts one of the largest percentage shares of the treaty and represents the other participating reinsurers in negotiating price, terms and conditions. TRH believes that this strategy has enabled it to influence more effectively the terms and conditions of the treaties in which it has participated. TRH has generally not set terms and conditions as lead underwriter with respect to AIG Group treaty reinsurance, although it may do so in the future. When TRH does not lead the treaty, it may still suggest changes to any aspect of the treaty. In either case, TRH may reject any treaty business offered to it by the AIG Group or others based upon its assessment of all relevant factors. Such factors include type and level of risk assumed, actuarial and underwriting judgment with respect to rate adequacy, various treaty terms, prior and anticipated loss experience on the treaty, prior business experience with the ceding company, overall financial position, operating results and Best's, S&P and Moody's ratings of the ceding company and social, legal, regulatory, environmental and general economic conditions affecting the risks assumed or the ceding company.
TRH currently has approximately 5,125 treaties in effect for the current underwriting year. In 1998, no single treaty exceeded 3% of treaty gross premiums written. No ceding company accounted for more than 4% of total treaty gross premiums written in 1998 other than AIG Group companies (see 'Relationship with the AIG Group') and members of Lloyd's of London, which accounted for 9% of treaty gross premiums written.
Non-U.S. treaty business accounted for approximately 47% of TRH's total net premiums written for the year ended December 31, 1998.
FACULTATIVE REINSURANCE
During 1998, TRH wrote approximately $128.4 million of gross premiums written and $73.5 million of net premiums written of facultative reinsurance, approximately 73% of which represented casualty risks with the balance comprising property risks. The majority of facultative gross premiums written in 1998 represented facultative reinsurance written on an excess-of-loss basis. Facultative coverages are generally offered for most lines of business. However, the great majority of premiums are within the other liability (including specialty casualty classes) and fire lines. Underwriting expenses associated with facultative business are generally higher in proportion to related premiums than those associated with treaty business, reflecting, among other things, the more labor-intensive nature of underwriting and servicing facultative business. Approximately 51% of facultative gross premiums written in 1998 were attributable to AIG Group companies. Except for AIG Group companies, no single ceding company accounted for more than 5% of total facultative gross premiums written in 1998. Non-U.S. facultative business accounted for approximately 2% of TRH's total net premiums written for the year ended December 31, 1998.
RETENTION LEVELS AND RETROCESSION ARRANGEMENTS
TRH enters into retrocession arrangements for many of the same reasons primary insurers seek reinsurance, including reducing the effect of individual or aggregate losses and increasing gross premium writings and risk capacity without requiring additional capital.
Under TRH's underwriting guidelines and retrocession arrangements in effect at the end of 1998, the maximum net amounts generally retained per risk, the maximum amounts retroceded and the maximum gross capacities are set forth in the table below.
For 1999, TRH is protected by catastrophe reinsurance agreements that would generally result in a maximum net retention by TRH of $20 million, with a property catastrophe limit of up to $200 million.
Average gross lines and net retentions on risks assumed historically have been smaller than the maximums permissible under the underwriting guidelines. Underwriting guidelines, including gross lines and net retention levels, may be changed and limited exceptions are made by TRH from time to time.
Retrocession arrangements do not relieve TRH from its obligations to the insurers and reinsurers from whom it assumes business. The failure of retrocessionnaires to honor their obligations could result in losses to TRH. TRH holds substantial amounts of funds and letters of credit to collateralize reinsurance recoverables. Such funds and letters of credit can be drawn on for amounts remaining unpaid beyond contract terms. In addition, an allowance has been established for estimated unrecoverable amounts.
As of December 31, 1998, TRH had in place 53 active retrocessional arrangements for current and prior underwriting years with 362 retrocessionnaires, and reinsurance recoverable on paid and unpaid losses totaled $464.2 million. (See Note 12 of Notes to Consolidated Financial Statements for amounts recoverable from AIG Group companies.)
MARKETING
TRH provides property and casualty reinsurance capacity through brokers and directly to insurance and reinsurance companies in both the domestic and international markets. TRH believes its worldwide network of offices and its relationship with the AIG Group help position TRH to take advantage of market opportunities.
AIG Group business is obtained directly from the ceding company. No ceding company, other than the AIG Group companies, has accounted for more than 10% of TRH's revenues in any of the last five years.
Non-AIG Group treaty business is produced primarily through brokers, while non-AIG Group facultative business is produced both directly and through brokers. In 1998, approximately 87% of TRH's non-AIG Group business was written through brokers and the balance was written directly. Companies controlled by Aon Corporation, TRH's largest brokerage source of business, accounted for 19% of TRH's consolidated revenues and 21% of gross premiums written in 1998. In addition, TRH's largest 10 brokers accounted for an aggregate of approximately 61% of such gross premiums written. Brokerage fees generally are paid by reinsurers. TRH believes that its emphasis on seeking the lead position in non-AIG Group reinsurance treaties in which it participates is beneficial in obtaining business.
Brokers do not have the authority to bind TRH with respect to reinsurance agreements, nor does TRH commit in advance to accept any portion of the business that brokers submit to it. Reinsurance business from any ceding company, whether new or renewal, is subject to acceptance by TRH.
Effective January 1, 1995, TRC and Putnam entered into a quota share reinsurance agreement whereby TRC ceded 5% of its total reinsurance liabilities, net of retrocessions, to Putnam. Thereafter, TRC cedes 5% of its assumed reinsurance, net of other retrocessions, to Putnam pursuant to this quota share reinsurance agreement. Presently all of Putnam's business is assumed from TRC pursuant to this quota share reinsurance agreement. From January 1, 1991 through December 31, 1994, TRC ceded 33% of its assumed reinsurance, net of other retrocessions, to Putnam, pursuant to an agreement with terms similar to the current agreement discussed immediately above. These agreements were entered into for operational reasons and had no material impact on TRH's financial position or results of operations.
CLAIMS
Claims are managed by TRH's professional claims staff whose responsibilities include the review of initial loss reports, creation of claim files, determination of whether further investigation is required, establishment and adjustment of case reserves and payment of claims. In addition to claims assessment, processing and payment, the claims staff conducts comprehensive claims audits of both specific claims and overall claims procedures at the offices of selected ceding companies, which TRH believes benefit all parties to the reinsurance arrangement. Claims audits are conducted in the ordinary course of business. In certain instances, a claims audit may be performed prior to assuming reinsurance business.
RESERVES FOR UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
Significant periods of time may elapse between the occurrence of an insured loss, the reporting of the loss to the ceding company and the reinsurer, and the ceding company's payment of that loss and subsequent payments to the ceding company by the reinsurer. To recognize liabilities for unpaid losses and loss adjustment expenses (LAE), insurers and reinsurers establish reserves, which are balance sheet liabilities representing estimates of future amounts needed to pay claims and related expenses with respect to insured events which have occurred on or before the balance sheet date, including events which have not been reported to the ceding company.
Upon receipt of a notice of claim from the ceding company, TRH establishes its own case reserve for the estimated amount of the ultimate settlement, if any. Case reserves usually are based upon the amount of reserves recommended by the ceding company and may be supplemented by additional amounts as deemed necessary. In certain instances, TRH establishes case reserves even when the ceding company does not report any liability to the reinsurer.
TRH also establishes reserves to provide for the estimated expenses of settling claims, including legal and other fees, and the general expenses of administering the claims adjustment process (i.e., LAE), and the losses and loss adjustment expenses incurred but not reported (IBNR). TRH calculates LAE and IBNR reserves by using generally accepted actuarial reserving techniques to project the ultimate liability for losses and loss adjustment expenses. Such reserves are periodically revised by TRH to adjust for changes in the expected loss development pattern over time. TRH has an in-house actuarial staff which periodically reviews its loss reserves, and therefore does not retain any outside actuarial firm to review its loss reserves.
Losses and loss adjustment expenses, net of related reinsurance recoverable, are charged to income as incurred. Unpaid losses and loss adjustment expenses represent the accumulation of case reserves and IBNR. Provisions for inflation and 'social inflation' (e.g., awards by judges and juries which progressively increase in size at a rate exceeding that of general inflation) are implicitly considered in the overall reserve setting process as an element of the numerous judgments which are made as to expected trends in average claim severity. Legislative changes may also affect TRH's liabilities, and evaluation of the impact of such changes is made in the reserve setting process.
The methods of determining estimates for reported and unreported losses and establishing resulting reserves and related reinsurance recoverable are continually reviewed and updated, and adjustments resulting therefrom are reflected in income currently. The process relies upon the basic assumption that past experience, adjusted for the effect of current developments and likely trends, is an appropriate
basis for predicting future events. However, estimation of loss reserves is a difficult process, especially in view of changes in the legal and tort environment which impact the development of loss reserves and therefore quantitative techniques frequently have to be supplemented by subjective considerations and managerial judgment. In addition, trends that have affected development of liabilities in the past may not necessarily occur or affect liability development to the same degree in the future.
While the reserving process is difficult and subjective for the ceding companies, the inherent uncertainties of estimating such reserves are even greater for the reinsurer, due primarily to the longer-term nature of most reinsurance business, the diversity of development patterns among different types of reinsurance treaties or facultative contracts, the necessary reliance on the ceding companies for information regarding reported claims and differing reserving practices among ceding companies. Thus, actual losses and loss adjustment expenses may deviate, perhaps substantially, from estimates of reserves reflected in the Company's consolidated financial statements.
During the loss settlement period, which can be many years in duration, additional facts regarding individual claims and trends usually become known. As these become apparent, it usually becomes necessary to refine and adjust the reserves upward or downward and even then the ultimate net liability may be less than or greater than the revised estimates. TRH does not otherwise adjust downward those claims reported to it by ceding companies or discount any of its reserves for reported or unreported claims in any line of its business for anticipated investment income.
Included in TRH's reserves are amounts related to environmental impairment and asbestos-related illnesses, net of related reinsurance recoverable, which totaled $69 million as of December 31, 1998. The majority of TRH's environmental and asbestos-related liabilities arise from contracts entered into after 1984 and underwritten specifically as environmental or asbestos-related coverages rather than as standard general liability coverages where the environmental or asbestos-related liabilities were neither clearly defined nor specifically excluded. Significant uncertainty exists as to the ultimate settlement of these liabilities since, among other things, there are inconsistent court resolutions with respect to underlying policy intent and coverage and uncertainties as to the allocation of responsibility for resultant damages. (See Management's Discussion and Note 2(e) of Notes to Consolidated Financial Statements for further discussion.)
The 'Analysis of Consolidated Net Loss and Loss Adjustment Expense Reserve Development' which follows presents the development of balance sheet loss and loss adjustment expense reserves for calendar years 1988 through 1998. The upper half of the table shows the cumulative amounts paid during successive years related to the opening reserve. For example, with respect to the net loss and loss adjustment expense reserve of $889.7 million as of December 31, 1989, by the end of 1998 (nine years later) $678.6 million had actually been paid in settlement of those reserves. In addition, as reflected in the lower section of the table, the original reserve of $889.7 million was reestimated to be $953.9 million at December 31, 1998. This change from the original estimate would normally result from a combination of a number of factors, including losses being settled for different amounts than originally estimated. The original estimates will also be increased or decreased as more information becomes known about the individual claims and overall claim frequency and severity patterns. The net deficiency or redundancy depicted in the table, for any particular calendar year, shows the aggregate change in estimates over the period of years subsequent to the calendar year reflected at the top of the respective columns. For example, the net redundancy of $59.5 million at December 31, 1998 related to December 31, 1997 net loss and loss adjustment expense reserves of $2,522.7 million, represents the cumulative amount by which net reserves for 1997 have developed favorably during 1998.
Each amount other than the original reserves in the table below includes the effects of all changes in amounts for prior periods. For example, if a loss settled in 1991 for $150,000 was first reserved in 1988 at $100,000 and remained unchanged until settlement, the $50,000 deficiency (actual loss minus original estimate) would be included in the cumulative net deficiency in each of the years in the period 1988 through 1990 shown in the following table. Conditions and trends that have affected development of liability in the past may not necessarily occur in the future. Accordingly, it may not be appropriate to extrapolate future development based on this table.
ANALYSIS OF CONSOLIDATED NET LOSS AND LOSS ADJUSTMENT EXPENSE RESERVE DEVELOPMENT(1)(2)(3)
- ------------ (1) This table excludes data related to TRZ, a non-U.S. subsidiary acquired in the third quarter of 1996, for 1995 and prior years as such data is not available.
(2) This table is on a calendar year basis and does not present accident or underwriting year data.
(3) Data have been affected by transactions between TRH and the AIG Group. (See 'Relationship with the AIG Group' and Notes 10 and 12 of Notes to Consolidated Financial Statements.)
(4) Represents gross liability for unpaid losses and loss adjustment expenses net of related reinsurance recoverable.
ANALYSIS OF NET UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES AND NET REESTIMATED LIABILITY(1)
- ------------ (1) This table excludes data related to TRZ for 1995 and prior years.
The trend depicted in the latest development year in the reestimated net liability portion of the 'Analysis of Consolidated Net Loss and Loss Adjustment Expense Reserve Development' table and in the 'Analysis of Net Unpaid Losses and Loss Adjustment Expenses and Net Reestimated Liability' table reflects net favorable development. Net favorable development of $59.5 million was recorded in 1998 on losses occurring in prior years. (See Management's Discussion.)
The deficiencies shown in the table for the reserves carried for all years prior to 1993 generally reflect the adverse development for losses occurring from 1981 to 1985 which is common throughout the industry. A number of industry and external factors combined during this period to drive loss frequency and severity to unexpectedly high levels.
From 1988 to 1991, casualty business generally had increased as a percentage of net premiums written. As a result of this change in the underlying book of business, TRH believes that the length of time needed for TRH's unpaid loss and loss adjustment expense reserves to be ultimately paid for those years will generally continue to increase. For 1992 through 1998, the length of time needed for reserves to be ultimately paid may decrease compared to 1991 due, in large part, to a shift in the business mix towards lines with shorter loss payment patterns and the return of loss and loss adjustment expense reserves associated with the reduced participation in one of TRH's then largest assumed treaties from 1992 through 1995.
The following table presents a reconciliation of beginning and ending net reserve balances for the years indicated. For domestic subsidiaries, there is no difference in reserves for losses and loss adjustment expenses net of reinsurance recoverable on unpaid losses and loss adjustment expenses whether determined in accordance with generally accepted accounting principles or statutory accounting principles.
RECONCILIATION OF RESERVE FOR NET LOSSES AND LOSS ADJUSTMENT EXPENSES
- ------------ (1) In TRH's balance sheet and in accordance with Statement of Financial Accounting Standards (SFAS) No. 113, unpaid losses and loss adjustment expenses are presented before deduction of related reinsurance recoverable. (See Notes 2 and 5 of Notes to Consolidated Financial Statements.)
In each of 1998, 1997 and 1996, the increase in current year paid losses compared to the prior year is attributable, in large part, to increases in premium volume and a shift in the business mix to lines with shorter payment patterns in recent years, and in 1998 only, catastrophe losses paid. (See Management's Discussion for further analysis of incurred and paid loss activity.)
INVESTMENT OPERATIONS
TRH's investments must comply with the insurance laws of the state of New York, the state of domicile of TRC and Putnam, and of the other states and jurisdictions in which the Company and its subsidiaries are regulated. These laws prescribe the kind, quality and concentration of investments which may be made by insurance companies. In general, these laws permit investments, within specified limits and subject to certain qualifications, in federal, state and municipal obligations, corporate bonds, preferred and common stocks, real estate mortgages and real estate. The Finance Committee of the Company's Board of Directors and senior management oversee investments, establish TRH's investment strategy and implement investment decisions with the assistance of certain AIG Group companies, which act as financial advisors and managers of TRH's investment portfolio and, in connection therewith, make the selection of particular investments. Other than as set forth above, there are no guidelines or policies with respect to the specific composition of TRH's overall investment portfolio or the composition of its bond portfolio by rating or maturity. A significant portion of TRH's domestic investments are in tax-exempt bonds.
TRH's current investment strategy seeks to maximize after-tax income through a high quality diversified taxable bond and tax-exempt municipal bond portfolio, while maintaining an adequate level of liquidity. TRH adjusts its mix of taxable and tax-exempt investments, as appropriate, generally as a result of strategic investment and tax planning considerations. During recent years, the yields on bonds purchased have generally been lower than yields on bonds sold or otherwise disposed of. Tax-exempt bonds carry lower pre-tax yields than taxable bonds that are comparable in risk and term to maturity due to their tax-advantaged status. (See Management's Discussion.) The equity portfolio is structured to achieve capital appreciation primarily through investment in quality growth companies. The great majority of other invested assets represent investments in partnerships.
The following table reflects investment results for TRH for each of the five years in the period ended December 31, 1998.
INVESTMENT RESULTS
- ------------ (1) Average of the beginning and ending carrying values of investments and cash for the year, excluding non-interest bearing cash. Bonds available for sale, common stocks, nonredeemable preferred stocks and other invested assets are carried at fair market value. Other bonds and redeemable preferred stocks are carried at amortized cost.
(2) After investment expenses, excluding realized net capital gains.
(3) Pre-tax net investment income for the year divided by average investments for the same year.
The following table summarizes the investments of TRH (on the basis of carrying value) as of December 31, 1998:
The carrying value of bonds and equities available for sale are subject to significant volatility from changes in their market values. (See Management's Discussion.)
As of December 31, 1998, the market value of the total investment portfolio was $4,344.3 million.
The following table indicates the composition of the bond portfolio of TRH by rating as of December 31, 1998:
At December 31, 1998, TRH had no real estate or derivative instruments. (See Note 3 of Notes to Consolidated Financial Statements.)
In addition, TRH's operations are exposed to market risk which could result in the loss of fair market value resulting from adverse fluctuations in interest, foreign currency exchange rates and equity prices. TRH has performed a Value at Risk (VaR) analysis to determine the maximum loss of fair value that could occur over a period of one month at a confidence level of 95%. (See Management's Discussion).
COMPETITION
The reinsurance business is highly competitive in virtually all lines. With certain limited exceptions, conditions (including pricing and contract terms) in these lines have continued to weaken in recent years. With the property and casualty insurance and reinsurance industry just having completed its eleventh consecutive year of generally soft market conditions, the Company cannot predict with any reasonable certainty, if, when or to what extent market conditions as a whole will improve.
TRH faces competition from new market entrants and from market participants that devote greater amounts of capital to the types of business written by TRH. In recent years, increased market capacity, significant domestic and international merger and acquisition activity, and since 1996, the reemergence of Lloyd's of London, have added to competitive pressures. The ultimate impact on the market of these events is uncertain.
Competition in the types of reinsurance in which TRH is engaged is based on many factors, including the perceived overall financial strength of the reinsurer, Best's, S&P and Moody's ratings, the states or other jurisdictions where the reinsurer is licensed, accredited, authorized or can serve as a reinsurer, premiums charged, other terms and conditions of the reinsurance offered, services offered, speed of claims payment and reputation and experience in the lines of business underwritten.
TRH competes in the United States and international reinsurance markets with numerous major international reinsurance companies and numerous domestic reinsurance companies, some of which have greater financial and other resources than TRH. While TRC and Putnam, on a combined basis, would rank 4th, on the basis of statutory net premiums written, they are a less significant reinsurer in international reinsurance markets. TRH's competitors include independent reinsurance companies, subsidiaries or affiliates of established worldwide insurance companies, reinsurance departments of certain primary insurance companies and domestic and European underwriting syndicates. Many of these competitors have been operating for substantially longer than TRH and have established long-term and continuing business relationships throughout the industry, which can be a significant competitive advantage. Although most reinsurance companies operate in the broker market, most of TRH's largest competitors work directly with ceding companies, competing with brokers. According to the Reinsurance Association of America, there were 38 domestic reinsurers for which results were reported in their quarterly survey as of December 31, 1998.
TRH believes that the reinsurance industry, including the brokerage industry, will continue to undergo further consolidation (i.e., the largest reinsurers will write a larger portion of total industry premiums) and, to compete effectively, significant size and financial strength will attain even greater importance.
EMPLOYEES
At December 31, 1998, TRH had approximately 370 employees. Approximately 189 employees were located in the New York headquarters; 36 employees were located in Chicago and Miami (serving Latin America) and 145 employees were located in other international offices. None of TRH's employees in the United States are represented by labor unions.
REGULATION
The rates and contract terms of reinsurance agreements are generally not subject to regulation by any governmental authority. This contrasts with primary insurance agreements, the rates and policy terms of which are generally closely regulated by state insurance departments. As a practical matter, however, the rates charged by primary insurers and the policy terms of primary insurance agreements may affect the rates charged and the policy terms associated with reinsurance agreements.
The Company, TRC, TRZ and Putnam are subject to the insurance statutes, including insurance holding company statutes, of various states and jurisdictions. The insurance holding company laws and regulations vary from jurisdiction to jurisdiction, but generally require domestic insurance holding companies and insurers and reinsurers that are subsidiaries of insurance holding companies to register with the applicable state regulatory authority and to file with that authority certain reports which provide information concerning their capital structure, ownership, financial condition and general business operations.
Such holding company laws generally also require prior regulatory agency approval of changes in direct or indirect control of an insurer or reinsurer and of certain material intercorporate transfers of assets within the holding company structure. The New York Insurance Law provides that no corporation or other person, except an authorized insurer, may acquire direct control of TRC or Putnam, or acquire control of the Company and thus indirect control of TRC and Putnam, unless such
corporation or person has obtained the prior approval of the New York Insurance Department for such acquisition. For the purposes of the New York Insurance Law, any investor acquiring ten percent or more of the Common Stock of the Company would be presumed to be acquiring 'control' of the Company and its subsidiaries, unless the New York Insurance Department determines upon application that such investor would not control the Company. An investor who would be deemed to be acquiring control of the Company would be required to obtain the approval of the New York Insurance Department prior to such acquisition. In addition, such investor would become subject to various ongoing reporting requirements in New York and in certain other states.
TRC, TRZ and Putnam, in common with other reinsurers, are subject to regulation and supervision by the states and by other jurisdictions in which they do business. Within the United States, the method of such regulation varies but generally has its source in statutes that delegate regulatory and supervisory powers to an insurance official. The regulation and supervision relate primarily to the standards of solvency that must be met and maintained, including risk-based capital measurements, the licensing of reinsurance, the nature of and limitations on investments, restrictions on the size of risks which may be insured under a single contract, deposits of securities for the benefit of ceding companies, methods of accounting, periodic examinations of the affairs of insurance companies, the form and content of reports of financial condition required to be filed, and reserves for unearned premiums, losses and other purposes. In general, such regulation is for the protection of the ceding companies and, ultimately, their policyholders rather than securityholders.
Risk Based Capital (RBC) is designed to measure the adequacy of an insurer's statutory surplus in relation to the risks inherent in its business. Thus, inadequately capitalized insurance companies may be identified. The RBC formula develops a risk adjusted target level of statutory surplus by applying certain factors to various asset, premium and reserve items. Higher factors are applied to items deemed to have more risk by the National Association of Insurance Commissioners and lower factors are applied to items that are deemed to have less risk. Thus, the target level of statutory surplus varies not only as a result of the insurer's size, but also on the risk profile of the insurer's operations. The RBC Model Law provides for four incremental levels of regulatory attention for insurers whose surplus is below the calculated RBC target. These levels of attention range in severity from requiring the insurer to submit a plan for corrective action to placing the insurer under regulatory control. The statutory surplus of each of the Company's domestic subsidiaries significantly exceeded the risk-based capital requirements as of December 31, 1998.
TRC and Putnam are subject to examination of their affairs by the insurance departments of the states in which they are licensed, authorized or accredited. The insurance department of New York, TRC's and Putnam's domiciliary state, generally conducts a triennial examination of insurance companies domiciled in New York. The most recent examinations of TRC and Putnam covered the years from 1989 for TRC and 1990 for Putnam through December 31, 1993. The report on examination for TRC has not been filed. The Putnam report was filed as of November 22, 1995. The Putnam report and reports filed related to the immediately prior triennial examinations of both companies disclosed no material deficiencies.
Through the 'credit for reinsurance' mechanism, TRC and Putnam are indirectly subject to the effects of regulatory requirements imposed by jurisdictions in which TRC's and Putnam's ceding companies are licensed. In general, an insurer which obtains reinsurance from a reinsurer that is licensed, accredited or authorized by the state in which the insurer files statutory financial statements is permitted to take a credit on its statutory financial statements in an aggregate amount equal to the reinsurance recoverable on paid losses and the liabilities for unearned premiums and loss and loss adjustment expense reserves ceded to the reinsurer, subject to certain limitations where amounts of reinsurance recoverable on paid losses are more than 90 days overdue. Certain states impose additional requirements that make it difficult to become so authorized, and certain states do not allow credit for reinsurance ceded to reinsurers that are not licensed or accredited in that state without additional provision for security.
In addition to licensing requirements, TRH's international operations are also regulated in various jurisdictions with respect to currency, amount and type of security deposits, amount and type of reserves and amount and type of local investment, and are subject to local economic, political and social
conditions. In addition, TRH's results of operations and net unrealized currency translation gain or loss (a component of accumulated other comprehensive income) are subject to volatility as the value of the foreign currencies fluctuate relative to the U.S. dollar. (See Note 7 of Notes to Consolidated Financial Statements.) Regulations governing constitution of technical reserves and remittance balances in some countries may hinder remittance of profits and repatriation of assets.
RELATIONSHIP WITH THE AIG GROUP
AIG
AIG is a holding company which, through its subsidiaries, is primarily engaged in a broad range of insurance and insurance-related activities and financial services in the United States and abroad. U.S.-based property and casualty insurance subsidiaries of AIG currently attain the highest rating classification assigned by Best's and S&P. The AIG Group is one of the largest purchasers of reinsurance in the insurance industry based on premiums ceded.
CONTROL OF THE COMPANY
During 1998, AIG increased its 49% beneficial ownership of the Company's outstanding common stock to 52% as of year end. As of March 11, 1999, AIG's beneficial ownership interest increased to approximately 55% as a result of additional share purchases. Four of the Company's 10 current directors, including the Chairman, are officers of AIG and hold the following positions with AIG: Mr. Greenberg is a Director and the Chairman and Chief Executive Officer; Mr. Matthews is a Director and Vice Chairman; Mr. Smith is a Director and the Executive Vice President, Chief Financial Officer and Comptroller and Mr. Tizzio is a Director and Senior Vice Chairman.
AIG GROUP REINSURANCE
From 1977 through June 1990, TRH and AIG had an agreement granting TRH a right of first acceptance to participate in substantially all property and casualty reinsurance purchased by the AIG Group. AIG continues to grant TRH a right of first acceptance under terms similar to those in effect under the above mentioned agreement. TRH either accepts or rejects the AIG Group reinsurance offered based upon TRH's assessment of risk selection, pricing, terms and conditions. Historically, and with few exceptions, TRH has generally not set terms and conditions as lead underwriter with respect to the AIG Group treaty reinsurance; however, TRH may in the future set terms and conditions with respect to such business as lead underwriter and intends that the terms and conditions of any such reinsurance will be negotiated on an arms' length basis. The operating management of TRH is not employed by the AIG Group, and the Underwriting Committee of the Board of Directors of the Company, which includes directors of the Company who are not employees of the AIG Group, monitor TRH's underwriting policies.
Approximately $167 million (11%), $181 million (12%) and $232 million (18%) of gross premiums written by TRH in the years 1998, 1997 and 1996, respectively, were attributable to reinsurance purchased by the AIG Group, for the production of which TRH paid ceding commissions to the AIG Group of approximately $31 million, $32 million and $33 million, respectively, in such years. TRH has no goal with respect to the proportion of AIG Group versus non-AIG Group business it accepts. TRH's objective in determining its business mix is to evaluate each underwriting opportunity individually with a view to maximizing overall underwriting results.
TRH retroceded gross premiums written to the AIG Group in the years 1998, 1997 and 1996 of approximately $93.4 million, $84.4 million and $80.8 million, respectively, and received ceding commissions of approximately $12.4 million, $8.4 million and $8.0 million, respectively, for the production of such business in such years.
ITEM 2.
ITEM 2. PROPERTIES
One-half of the office space of TRH's New York headquarters, and its Hong Kong and Toronto offices are rented from AIG, which either owns the property or leases it from others. The remaining
office space of TRH's headquarters and the Chicago, Miami, Buenos Aires, Rio de Janeiro, Zurich, London, Paris, Shanghai and Tokyo offices, are rented from third parties. The leases for the office space occupied by TRH's New York headquarters expire in 2005.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
TRH, in common with the reinsurance industry in general, is subject to litigation in the normal course of its business. TRH does not believe that any pending litigation will have a material adverse effect on its consolidated results of operations, financial position or cash flows.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the fourth quarter of 1998.
DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The table below sets forth the names, positions and ages of the persons who are the directors and executive officers of the Company as of March 25, 1999.
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(1) Prior to April 1990, such person was a director or an officer of TRC and Putnam, but not of the Company.
(2) Prior to May 1994, Mr. Bonny was an officer of TRC and Putnam, but not of the Company.
(3) Mr. Vijil was elected as an Executive Vice President, President Latin American Division of the Company in October 1998. From May 1996 to October 1998, Mr. Vijil was a Senior Vice President of the Company. From November 1994 to May 1996, Mr. Vijil was a Senior Vice President of TRC and Putnam, but not of the Company. From August 1993 to November 1994, Mr. Vijil was an officer of TRC and Putnam, but not of the Company.
(4) Mr. Allard was elected as a Vice President and General Counsel of the Company in June 1998. From May 1996 to May 1998, Mr. Allard was an officer of CNA. From August 1994 to May 1996, Mr. Allard was an officer of Professional Claims Managers, Inc. From July 1990 to August 1994, Mr. Allard was an officer of Great American Insurance Company.
Except as noted, each of the executive officers has, for more than five years, occupied an executive position with the Company or companies that are now its subsidiaries. For more than one year prior to joining the Company in February 1995, Mr. Skalicky served as an officer of certain AIG Group companies, with his most recent position as Assistant Vice President and Deputy Comptroller, AIG. Since January 1991, Ms. Tuck has also served as the Secretary of a number of AIG Group companies.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
(a) The following table sets forth the high and low closing sales prices per share of the Company's Common Stock, as reported on the New York Stock Exchange Composite Tape for each of the four quarters of 1998 and 1997, as adjusted for the 3-for-2 common stock split effected in the form of a 50% stock dividend, paid on July 18, 1997:
(b) As of January 31, 1999, the approximate number of holders of Common Stock, including those whose Common Stock is held in nominee name, was 5,000.
(c) In 1998, the Company declared a quarterly dividend of $0.10 per common share in March and $0.11 per common share in each of May, October, and December. In 1997, the Company declared a quarterly dividend of $0.09 per common share in March and $0.10 per common share in each of May, September and December. The Company paid each dividend in the quarter following the date of declaration except for the October 1998 dividend, which was paid in the same quarter as the date of declaration. All dividend information has been adjusted to reflect the 3-for-2 stock split paid on July 18, 1997.
The declaration and payment of future dividends, if any, by the Company will be at the discretion of the Board of Directors and will depend upon many factors, including the Company's consolidated earnings, financial condition and business needs, capital and surplus requirements of the Company's operating subsidiaries, regulatory considerations and other factors.
The Company is a holding company whose principal source of income is dividends from TRC. The payment of dividends by TRC and its wholly-owned subsidiaries, TRZ and Putnam, is restricted by insurance regulations. (See Note 11 of Notes to Consolidated Financial Statements.)
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
TRANSATLANTIC HOLDINGS, INC. AND SUBSIDIARIES
The following Selected Consolidated Financial Data is prepared in accordance with generally accepted accounting principles. This data should be read in conjunction with the Consolidated Financial Statements and accompanying notes included elsewhere herein.
- ------------ (1) TRH, through its wholly-owned subsidiary TRC, acquired Trans Re Zurich (TRZ) in the third quarter of 1996. TRZ's results for the second half of 1996 and thereafter are included in the Consolidated Financial Statements and accompanying notes included elsewhere herein.
(2) Share and per share data have been retroactively adjusted to reflect a 3-for-2 common stock split effected in the form of a 50% stock dividend, paid July 18, 1997.
(3) All periods reflect the adoption of the accounting standard related to earnings per share (SFAS No. 128).
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FINANCIAL STATEMENTS
The following discussion refers to the consolidated financial statements of Transatlantic Holdings, Inc. and its subsidiaries (TRH) as of December 31, 1998 and 1997 and for each of the three years in the period ended December 31, 1998, which are presented elsewhere herein.
During 1998, American International Group, Inc. (AIG, and collectively, with its subsidiaries, the AIG Group) increased its 49% beneficial ownership of Transatlantic Holdings, Inc. (the 'Company') outstanding common stock to 52% as of year end. Financial data discussed below have been affected by certain transactions between TRH and the AIG Group. (See Notes 10 and 12 of Notes to Consolidated Financial Statements.)
ACQUISITION OF TRANS RE ZURICH
In the third quarter of 1996, the Company, through its wholly-owned subsidiary, Transatlantic Reinsurance Company (TRC), acquired all of the outstanding shares of Trans Re Zurich (TRZ), formerly known as Guardian Ruckversicherungs-Gesellschaft (Guardian Re), an international reinsurance company based in Zurich, Switzerland, for approximately $105 million in cash. Assets of TRZ totaled $366.8 million at the date of acquisition.
This acquisition was accounted for as a purchase. Accordingly, TRZ's results for the second half of 1996 and thereafter are included in the consolidated results of the Company. This acquisition has not had a material effect on financial position or net income.
OPERATIONAL REVIEW
TRH derives its revenue from two principal sources: premiums from reinsurance assumed net of reinsurance ceded (i.e., net premiums earned) and income from investments. Gross premiums assumed and reinsurance ceded are initially deferred and then are credited or charged to income, respectively, over the terms of the underlying contracts or certificates in force. The deferred amounts constitute the unearned premium reserve or prepaid reinsurance premium and are generally ratably credited or charged, respectively, to income over the contract periods. The relationship between net premiums written and net premiums earned will, therefore, vary depending generally on the volume and inception dates of the business assumed and ceded and the mix of such business between pro rata and excess-of-loss reinsurance.
The following table shows net premiums written, net premiums earned and net investment income of TRH for the periods indicated:
Increasingly in more recent years, the reinsurance market has been characterized by significant competition worldwide in most classes. The increases in net premiums written were primarily from treaty business and resulted from increased coverage provided. On a worldwide basis, casualty lines business represented 71.0% of net premiums written in 1998 versus 67.1% in the prior year. The balance represented property lines. Treaty business represented 94.7% of net premiums written versus 93.8% in the prior year. The balance represented facultative accounts.
Net premiums written by international offices increased in 1998 by $57.8 million, or 9.3%, over the prior year, to $682.0 million. Most international offices recorded increases in net premiums written, led by Paris and London. TRZ recorded a significant decrease compared to 1997 as a result of the shift of
their business to certain other TRH offices, closer to source, and the selective retention of business in its core areas. International net premiums written increased significantly in specialty casualty classes (particularly other professional liability), automobile physical damage, automobile liability and aircraft lines, and decreased significantly in the fire line. International business represented 48.9% of 1998 net premiums written compared to 48.2% in 1997.
Domestic net premiums written increased by $41.7 million, or 6.2%, over 1997, to $711.7 million, with significant increases recorded in the automobile liability line (including nonstandard risks) and certain specialty casualty classes (particularly other professional liability and accident and health lines), and a significant decrease recorded in the medical malpractice line.
Net premiums written increased in 1997 compared to the prior year, generally as a result of more favorable conditions in certain sectors of the market in 1997 as compared to other sectors, and due to the inclusion of a full year of net premiums written from TRZ in 1997 compared to six months net premiums written in 1996, when TRZ was acquired. Such net premiums written by TRZ amounted to $172.3 million in 1997 and $78.2 million in 1996.
Net premiums written by international offices increased by $161.5 million, or 34.9%, to $624.2 million in 1997. Nearly all such offices recorded premium increases, led by TRZ, which reported an increase of $94.1 million as discussed in the paragraph immediately above. International net premiums written increased significantly in automobile liability, automobile physical damage, fire and allied lines. International business represented 48.2% of total net premiums written in 1997 as compared to 40.5% in 1996. Domestic net premiums written decreased 1.5% to $669.9 million. Significant decreases in general casualty, property and automobile liability lines (including nonstandard risks) were partially offset by increases in homeowners' multi-peril, aircraft and accident and health lines. On a worldwide basis, casualty lines business represented 67.1% of net premiums written in 1997 compared to 66.5% in the prior year. The balance represented property lines. Treaty business represented 93.8% of net premiums written compared to 90.5% in 1996. The balance represented facultative accounts. The net increases noted above were primarily from treaty business and resulted from increased coverage provided.
The increase in net premiums earned in each of 1998 and 1997 compared to the respective prior year amounts resulted primarily from the significant growth in net premiums written in both years. Net investment income grew each year due to significant cash flow available for investment which was generated by operating activities. The percentage of growth has decreased in each succeeding year due to generally lower available yields on bonds purchased as compared to yields on bonds disposed of in recent years and reduced operating cash flow in 1998 and 1997 compared to the immediately preceding year. In 1997, the lower yields are also due to the fact that TRH had primarily been purchasing tax- exempt bonds for its domestic portfolio to benefit its after-tax results. Tax-exempt bonds carry lower pre-tax yields than taxable bonds that are comparable in risk and term to maturity due to their tax-advantaged status. In addition, in 1997 compared to 1996, $9.5 million of the increase in net investment income emanated from TRZ, due to the inclusion of its net investment income in 1996 only subsequent to its mid-year acquisition date. (See Note 3 of Notes to Consolidated Financial Statements.)
The property and casualty insurance and reinsurance industries use the combined ratio as a measure of underwriting profitability. The combined ratio reflects only underwriting results, and does not include income from investments. Generally, a combined ratio under 100 indicates an underwriting profit and a combined ratio exceeding 100 indicates an underwriting loss.
The following table sets forth TRH's combined ratios and the components thereof for the years indicated:
TRH's 1998 results included losses incurred of $20 million related to Hurricane Georges. In addition, as a result of net decreases in estimates of losses occurring in prior years, net losses and loss adjustment expenses were reduced by $59.5 million in 1998. Significant favorable development was recorded in 1998 on losses occurring in years subsequent to 1986 in the other liability line, in 1996 and 1997 in the medical malpractice line and in 1993 through 1996 in the fire and allied lines. These reductions to incurred losses were partially offset by adverse development in 1998 on losses occurring in 1996 and 1997 in the ocean marine line, prior to 1984 in the other liability line and in 1997 in the fire line.
TRH's 1997 results did not include any significant catastrophe loss activity. In addition, as a result of net decreases in estimates of losses occurring in prior years, net losses and loss adjustment expenses were reduced by $14.6 million in 1997. Significant favorable development was recorded in 1997 on losses occurring in years subsequent to 1986 in the other liability line, in 1996 in the medical malpractice line and in 1995 and 1994 in certain property lines. These reductions to incurred losses were partially offset by adverse development in 1997 on losses occurring in 1996 in aircraft and surety lines, in 1995 and 1994 in the medical malpractice line and in 1983 and prior in the other liability line.
TRH's 1996 results did not include any significant catastrophe loss activity. In addition, as a result of net decreases in estimates of losses occurring in prior years, net losses and loss adjustment expenses incurred were reduced by $7.7 million in 1996. In the other liability line, favorable development on losses occurring in more recent years was offset by adverse development in 1984 and prior years. In addition, in more recent years, favorable development, particularly in the fire, allied line and aircraft lines was partially offset by adverse development in the automobile liability line.
At December 31, 1998, reserves for unpaid losses and loss adjustment expenses totaled $3.12 billion, an increase of $197.3 million, or 6.8%, over the prior year. Also at December 31, 1998, reinsurance recoverable on unpaid losses and loss adjustment expenses totaled $446.9 million, an increase of $64.1 million, or 16.8%, from the prior year. (See Note 12 of Notes to Consolidated Financial Statements.) TRH's reserves and related recoverables represent estimates of all future liability and reinsurance recoverable thereon for losses occurring on or prior to the balance sheet date. Net losses and loss adjustment expenses are charged to income as incurred. Unpaid losses and loss adjustment expenses are principally based on reports and individual case estimates received from ceding companies. A provision is included for losses and loss adjustment expenses incurred but not reported on the basis of past experience and other factors. The methods of making such estimates and for establishing the resulting reserves and related recoverables are continually reviewed and updated, and any adjustments resulting therefrom are reflected in income currently. Provisions for inflation and 'social inflation' (e.g., awards by judges and juries which progressively increase in size at a rate exceeding that of general inflation) are implicitly considered in the overall reserve setting process as an element of numerous judgments which are made as to expected trends in average claim severity. Because the reserving process is inherently difficult and subjective, actual net losses and loss adjustment expenses may deviate, perhaps substantially, from estimates of reserves and reinsurance recoverable on such amounts reflected in TRH's consolidated financial statements.
Reserves for the reinsurance of risks related to environmental impairment and asbestos-related illnesses amounted to $69 million and $74 million at December 31, 1998 and 1997, respectively. The majority of TRH's environmental and asbestos-related liabilities arise from contracts entered into after 1984. These obligations generally arose from contracts underwritten specifically as environmental or asbestos-related coverages rather than from standard general liability coverages where the environmental or asbestos-related liabilities were neither clearly defined nor specifically excluded. The reserves carried for such claims, including incurred but not reported claims (IBNR), are based upon known facts and current law. However, significant uncertainty exists as, among other things, there are inconsistent court resolutions with respect to underlying policy intent and coverage and uncertainties as to the allocation of responsibility for resultant damages. Further, while there is always the threat of changes in statutes, laws, regulations and other factors that could have a material effect on these liabilities and, accordingly, future earnings, TRH believes that these claims reserves, as well as all other claims reserves carried at December 31, 1998, are adequate.
The increase of the underwriting expense ratio in 1998 compared to 1997 and the decrease of the underwriting expense ratio in 1997 compared to 1996 were both due to changes in the ratio of net commissions to net premiums written, caused, in large part, by slight shifts in the mix of business between years.
Other deductions generally include currency transaction gains and losses and other miscellaneous income and expense items.
Realized net capital gains on the disposition of investments totaled $120.9 million in 1998, $32.9 million in 1997 and $18.7 million in 1996. The high level of realized capital gains in 1998 compared to the other years presented resulted principally from the strategic realignment of the equity portfolio.
Income before income taxes was $323.4 million in 1998, $234.7 million in 1997 and $196.3 million in 1996. The increase in income before income taxes in 1998 over 1997 resulted from increased realized capital gains and net investment income partially offset by a deterioration in underwriting results caused by losses from Hurricane Georges. The increase in income before income taxes in 1997 over the prior year resulted from increased net investment income and realized net capital gains, and improved underwriting results.
The provisions for federal and foreign income taxes were $75.8 million in 1998, $49.2 million in 1997 and $41.5 million in 1996. The Company and its domestic subsidiaries, TRC and Putnam Reinsurance Company (Putnam), filed consolidated federal income tax returns for the years under discussion, except those for 1998 which are not yet due. The tax burden among the companies is allocated in accordance with a tax sharing agreement. TRC will include as part of its taxable income those items of income of the non-U.S. subsidiary, TRZ, which are subject to U.S. income tax currently, pursuant to Subpart F income rules of the Internal Revenue Code, and included, as appropriate, in the consolidated federal income tax return.
The effective tax rates were 23.5% in 1998, 21.0% in 1997 and 21.1% in 1996. The increased effective tax rate in 1998 is due to the fact that while tax-exempt income remained relatively level compared to the prior year, income subject to tax increased significantly, principally as a result of the increase in realized net capital gains.
Net income and net income per common share on a diluted basis, respectively, were as follows: 1998 -- $247.5 million, $7.10; 1997 -- $185.5 million, $5.34; 1996 -- $154.9 million, $4.48. Reasons for these increases are as discussed above. Per share amounts have been retroactively adjusted to reflect the 3-for-2 common stock split paid in July 1997. (See Note 2(j) of Notes to Consolidated Financial Statements.)
FINANCIAL CONDITION AND LIQUIDITY
As a holding company, the Company's assets consist primarily of the stock of TRC and the Company's future cash flows depend on the availability of dividends or other statutorily permissible payments from TRC and its wholly-owned operating subsidiaries, TRZ and Putnam. (See Note 11 of Notes to Consolidated Financial Statements for a discussion of restrictions on dividend payment.) During 1998, the Company received cash dividends of $14.9 million from TRC. Sources of funds for the operating subsidiaries consist primarily of premiums, reinsurance recoverables, investment income and proceeds from sales, redemptions and the maturing of investments. Funds are applied primarily to payments of claims, ceded reinsurance premiums, insurance operating expenses, income taxes and investments in fixed income and equity securities. Premiums are generally received substantially in advance of related claims payments. Cash and cash equivalents are maintained for the payment of claims and expenses as they become due. TRH does not anticipate any material capital expenditures in the foreseeable future.
At December 31, 1998, total investments and cash were $4,328.8 million compared to $3,992.5 million at December 31, 1997. This increase is principally due to net cash provided by operating activities which totaled $227.0 million in 1998, realized capital gains of $120.9 million and an increase during the year in net unrealized appreciation of investments available for sale of $4.9 million. (See Note 3 of Notes to Consolidated Financial Statements.)
TRH's operating cash flow in 1998 declined compared to 1997. This decrease was due to a significant increase in paid losses and taxes paid and lesser increases in net commissions and operating expenses, offset in part by increased net premiums and net investment income received. In addition, TRH's operating cash flow in 1997 declined compared to 1996. This decrease was due to a significant increase in paid losses and lesser increases in net commissions, operating expenses and taxes paid, offset in part by increased net premiums and net investment income received. In each of 1998 and 1997 as compared to the respective prior year, the increase in paid losses was principally due to increases in premium volume, a shift in the business mix in more recent years towards lines with shorter loss payment patterns, and in 1998, increased catastrophe losses paid. International operations, most significantly London, accounted for approximately 43%, 43% and 41% of operating cash flow in 1998, 1997 and 1996, respectively.
TRH believes that its balance of cash and cash equivalents of $70.6 million as of December 31, 1998 and its future cash flows will be sufficient to meet TRH's cash requirements through the end of 1999 and thereafter for a period the length of which is difficult to predict, but which TRH believes will be at least one year.
TRH's fixed maturity investments, approximately 83.0% of total investments as of December 31, 1998, are predominantly investment grade, liquid securities concentrated in maturities of less than 10 years. Also as of that date, approximately 13.5% of total investments were in common and nonredeemable preferred stocks, approximately 2.9% of total investments were in other invested assets, including investments in partnerships, and the remaining 0.6% consisted of short-term investments. Based on the foregoing, TRH considers its liquidity to be adequate through the end of 1999 and thereafter for a period the length of which is difficult to predict, but which TRH believes will be at least one year.
As of December 31, 1998, a significant portion of the bond portfolio was classified as available-for-sale and carried at market value. Fixed maturity investments are carried at amortized cost when it is TRH's positive intent to hold these securities to maturity and TRH has the ability to do so. Most activity within the bonds available for sale portfolio for the years under discussion represented strategic portfolio realignments, partially for tax purposes. TRH adjusts its mix of taxable and tax-exempt investments, as appropriate, generally as a result of strategic investment and tax planning considerations. As of December 31, 1998, bonds held to maturity had gross unrealized gains of $86.1 million and no gross unrealized losses. Gross unrealized gains and losses on bonds available for sale as of December 31, 1998 amounted to $92.9 million and $6.5 million, respectively.
As of December 31, 1998, 92.3% of the bond portfolio were rated Aaa or Aa, an additional 4.0% were also rated investment grade or better, 2.8% were rated below investment grade and 0.9% were not rated. Also, as of December 31, 1998, TRH had no derivative instruments. (See Note 3 of Notes to Consolidated Financial Statements.)
TRH's operations are exposed to market risk. Market risk is the risk of loss of fair market value resulting from adverse fluctuations in interest and foreign currency exchange rates and equity prices.
Measuring potential losses in fair values has recently become the focus of risk management efforts by many companies. Such measurements are performed through the application of various statistical techniques. One such technique is Value at Risk (VaR). VaR is a summary statistical measure that uses historical interest and foreign currency exchange rates and equity prices and estimates the volatility and correlation of each of these rates and prices to calculate the maximum loss that could occur over a defined period of time given a certain probability.
TRH believes that statistical models alone do not provide a reliable method of monitoring and controlling market risk. While VaR models are relatively sophisticated, the quantitative market risk information generated is limited by the assumptions and parameters established in creating the related models. Therefore, such models are tools and do not substitute for the experience or judgment of senior management.
TRH has performed a VaR analysis to estimate the maximum potential loss of fair value for financial instruments for each type of market risk. In this analysis, financial instrument assets include all
investments and cash and accrued investment income. Financial instrument liabilities include unpaid losses and loss adjustment expenses, net of reinsurance, and unearned premiums.
TRH calculated the VaR as of December 31, 1998. This calculation used the variance-covariance (delta-normal) methodology. The calculation also used daily historical interest and foreign currency exchange rates and equity prices in the two years ended December 31, 1998. The VaR model estimated the volatility of each of these rates and equity prices and the correlation among them. For interest rates, each country's yield curve was constructed using eleven separate points on this curve to model possible curve movements. Inter-country correlations were also used. The redemption experience of municipal and corporate fixed maturities as well as the use of financial modeling were employed in the analysis process. Thus, the VaR measured the sensitivity of the asset and the liability portfolios to each of the aforementioned market risk exposures. Each sensitivity was estimated separately to capture the market risk. The following table presents the VaR of each component of market risk as of December 31, 1998:
Each sensitivity was then applied to a database which contained both historical ranges of movements in all market factors and the correlations among them. The results were aggregated to provide a single amount that depicts the maximum potential loss in fair value at a confidence level of 95 percent for a time period of one month. VaR with respect to the aggregate of the three components of market risk cannot be derived by summing the individual risk amounts in the table above. At December 31, 1998, the VaR for TRH's financial instruments was approximately $69 million.
TRH's stockholders' equity increased to $1.61 billion at December 31, 1998, an increase of $253.5 million over year-end 1997. The net increase was comprised principally of net income of $247.5 million and an increase in accumulated other comprehensive income of $17.8 million (principally unrealized currency translation gain, net of income taxes), partially offset by dividends declared of $14.9 million. Unrealized appreciation (depreciation) of investments, net of deferred income taxes, a component of accumulated other comprehensive income, is subject to significant volatility resulting from changes in the market value of bonds and equities available for sale. Market values may fluctuate due to changes in general economic conditions, market interest rates and other factors.
Risk-based capital (RBC) standards, promulgated by the National Association of Insurance Commissioners (NAIC), relate an individual company's statutory policyholders' surplus to the risk inherent in its overall operations and sets thresholds at which certain company and regulatory corrective actions are mandated. At December 31, 1998, the statutory surpluses of TRC and Putnam each significantly exceeded RBC requirements.
ACCOUNTING STANDARDS
In October 1995, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 123, 'Accounting for Stock-Based Compensation.' This statement established new financial accounting and reporting standards for stock-based employee compensation plans, including stock option and stock purchase plans. Compensation resulting from the award of stock-based compensation must be determined based on the fair value of consideration received or fair value of the equity instrument issued, whichever is more reliably measurable. Such compensation expense, net of income taxes, may be recognized in the Statement of Operations over the service period of the employee (generally the vesting period). In lieu of recording such compensation expense, entities are permitted to disclose its pro forma impact, net of income taxes, on reported net income and earnings per share. Entities choosing such disclosure will continue to measure compensation expense from stock-based compensation in the Statement of Operations based on the intrinsic value method prescribed in Accounting Principles Board (APB) No. 25, 'Accounting for Stock Issued to Employees.'
In accordance with the standard, TRH adopted SFAS No. 123 beginning with the 1996 annual financial statements and chose the pro forma disclosure option of implementation. (See Note 9 of Notes to Consolidated Financial Statements.)
In June 1996, the FASB issued SFAS No. 125, 'Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.' This statement provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities. In addition, it provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings.
SFAS No. 125 was effective as of January 1, 1997 and was to be applied prospectively. However, SFAS No. 127, 'Deferral of the Effective Date of Certain Provisions of SFAS No. 125,' deferred for one year the effective date of certain provisions of SFAS No. 125 which affect repurchase agreements, dollar-rolls, securities lending and similar transactions. The implementation of these standards, which occurred on their respective effective dates, did not have a material impact on results of operations, financial position or cash flows.
In February 1997, the FASB issued SFAS No. 128, 'Earnings Per Share.' As compared to the prior standard, SFAS No. 128 simplifies computational guidelines, revises disclosure requirements and increases earnings per share (EPS) comparability on an international basis.
Basic EPS, which is calculated by dividing net income by the weighted average number of common shares outstanding, replaced primary EPS from the prior standard. For all periods reported by TRH prior to implementation of the standard, basic EPS would have been the same as primary EPS, since the impact of the Company's common stock equivalents (principally stock options) for those periods did not reach the significance threshold prescribed to require adjustment under the prior standard. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. Diluted EPS is computed similarly to fully diluted EPS from the prior standard.
For all entities with complex capital structures, basic and diluted EPS must be shown on the face of the income statement with equal prominence. In addition, a reconciliation of the numerator and denominator from the basic EPS computation to the diluted EPS computation is required. (See Note 2(j) of Notes to Consolidated Financial Statements.)
Pursuant to the standard, TRH adopted SFAS No. 128 for the 1997 annual financial statements and restated all prior period EPS data presented.
Also in February 1997, the Securities and Exchange Commission (SEC) issued Financial Reporting Release (FRR) No. 48, 'Disclosure of Accounting Policies for Derivative Financial Instruments and Derivative Commodity Instruments and Disclosure of Quantitative and Qualitative Information about Market Risk Inherent in Derivative Financial Instruments, Other Financial Instruments, and Derivative Commodity Instruments.'
FRR No. 48 amends rules and forms for registrants and requires clarification and expansion of existing disclosures for derivative financial instruments, other financial instruments and derivative commodity instruments, as defined therein. The amendments require enhanced disclosure with respect to these derivative instruments in the notes to financial statements. During the three year period ending December 31, 1998, TRH has had no derivative instruments.
Additionally, the amendments expand existing disclosure requirements to include quantitative and qualitative discussions in Management's Discussion and Analysis of Financial Condition and Results of Operations (Management's Discussion) with respect to market risk inherent in market risk sensitive instruments such as equity and fixed maturity securities, as well as derivative instruments. These amendments are designed to provide additional information about market risk sensitive instruments which investors can use to better understand and evaluate market risk exposures of registrants. For TRH, these disclosures are included for 1998 in Management's Discussion which accompanies these financial statements and related notes.
In June 1997, the FASB adopted SFAS No. 130, 'Reporting Comprehensive Income.' This statement established standards for reporting and display of comprehensive income and its components
(revenues, expenses, gains and losses) in a full set of general-purpose financial statements. Comprehensive income is defined as the change in stockholders' equity during a period from transactions and other events and circumstances from non-owner sources and includes net income and all changes in stockholders' equity except those resulting from investments by owners and distribution to owners.
This standard requires that an enterprise (a) classify items of other comprehensive income by their nature in a financial statement and (b) display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of a statement of financial position.
In accordance with the standard, TRH adopted SFAS No. 130 in 1998. Comparable data from prior years are presented in conformity with the new standard.
Also in June 1997, the FASB adopted SFAS No. 131, 'Disclosure about Segments of an Enterprise and Related Information.' This statement establishes standards for the way that public business enterprises report information about operating segments in annual and interim financial statements and requires presentation of a measure of profit or loss, certain specific revenue and expense items and segment assets. It also establishes standards for related disclosures about products and services, geographic areas and major customers, superseding most of SFAS No. 14, 'Financial Reporting for Segments of a Business Enterprise.'
SFAS No. 131 requires that a public business enterprise report financial and descriptive information about its reportable operating segments. Generally, financial information is required to be reported on the basis that is used internally for evaluating segment performance and deciding how to allocate resources to segments. The enterprise must report information about the revenues derived, countries in which it earns revenues and holds assets and major customers regardless of whether that information is used in making operating decisions. However, this statement does not require an enterprise to report information that is not prepared for internal use if reporting it would be impracticable.
SFAS No. 131 is effective for TRH's 1998 financial statements. This statement need not be applied to interim financial statements in the initial year of its application, but comparative information for interim periods in the initial year of application is to be reported in financial statements for interim periods in the second year of application. TRH has adopted this standard for the 1998 annual financial statements and has provided comparable prior year data.
In June 1998, the FASB issued SFAS No. 133, 'Accounting for Derivative Instruments and Hedging Activities.' This statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. All derivatives must be recognized as either assets or liabilities in the balance sheet and measured at fair value. The accounting recognition for the change in the fair value of a derivative depends on a number of factors, including the intended use of the derivative. SFAS No. 133 is effective for TRH as of January 1, 2000 and may not be applied retroactively. TRH presently has no derivative instruments.
In October 1998, the American Institute of Certified Public Accountants (AICPA) issued Statement of Position (SOP) 98-7, 'Deposit Accounting: Accounting for Insurance and Reinsurance Contracts That Do Not Transfer Insurance Risk.' This statement provides guidance on how to account for insurance and reinsurance contracts that do not transfer both required elements of insurance risk (i.e., underwriting risk and timing risk). SOP 98-7 will be effective for TRH on January 1, 2000. Restatement of previously issued annual financial statements is not permitted. Management believes that the impact of applying this statement will not be material to results of operations, financial position or cash flows.
OTHER MATTERS
The Year 2000 (Y2K) issue arises from the historic usage of two, rather than four, digit date fields in computer equipment, software packages and other devices using embedded chip technology, causing a date field '00' to be recognized as the year 1900, rather than the year 2000. Failure to recognize, repair or replace affected devices and systems could cause systems failures or other disruptions resulting
in, among other things, an inability to process transactions, collect premiums, pay invoices or engage in similar normal business activities.
Most TRH systems and software packages were installed or purchased within the last five years, when the Y2K issue had already been identified and was usually a consideration in the development process. TRH has taken steps to identify its significant systems and programs, new and existing, hardware and software information technology (IT) as well as non-IT (e.g., telephone systems, fax machines and copiers), where Y2K failures could surface, and has effected remedial changes and conducted appropriate testing. This process is essentially complete for all critical systems. The costs associated with this process, which are expensed as incurred, have not had and are not expected to have a material effect on net income, financial position, cash flows or other non-Y2K IT projects and initiatives.
In addition, TRH has identified those ceding companies, brokers, reinsurers, vendors and other business partners (collectively 'third parties') that are significant to its business and has asked each to advise on the steps they are taking to address the Y2K issue. Responses have been received from most and follow-up requests have been sent to those who failed to respond or whose responses were not satisfactory. The completion of these activities and corrective actions, where necessary, will continue during 1999.
TRH does not presently believe that Y2K issues related to its internal IT and non-IT systems pose significant operational problems. Although TRH continues to monitor third party readiness, it cannot provide assurance that unresolved Y2K issues of such parties will not have a material adverse impact on TRH's operations or financial results. TRH will continue to consider the effects of potential unresolved Y2K issues of third parties on its business and develop contingency plans, as necessary. Such plans may include the selection of alternate third parties or other actions designed to mitigate the effects of a third party's lack of preparedness.
On January 1, 1999, certain of the member nations of the European Economic and Monetary Union (EMU) adopted a common currency, the Euro. Once the national currencies are phased out, the Euro will be the sole legal tender of each of these nations. During the transition period, commerce of these nations will be transacted in the Euro or in the currently existing national currency.
TRH has taken the necessary steps to transact business in the Euro, has identified the significant issues and will be prepared with respect to the continued phase in of and ultimate redenomination to the Euro. Any costs associated with the adoption of the Euro are expensed as incurred and are not material to TRH's net income, financial position or cash flows.
Any statements contained in this discussion that are not historical facts, or that might be considered an opinion or projection, whether expressed or implied, are meant as, and should be considered, forward-looking statements as that term is defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based on assumptions and opinions concerning a variety of known and unknown risks. If any assumptions or opinions prove incorrect, any forward-looking statements made on that basis may also prove materially incorrect.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
TRANSATLANTIC HOLDINGS, INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
Schedules:
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of TRANSATLANTIC HOLDINGS, INC.:
In our opinion, the consolidated financial statements listed in the index on page 31 of this Form 10-K present fairly, in all material respects, the financial position of Transatlantic Holdings, Inc. and Subsidiaries at December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. In addition, in our opinion, the financial statement schedules listed in the index on page 31 of this Form 10-K present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedules are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.
PRICEWATERHOUSECOOPERS LLP
New York, New York February 8, 1999
TRANSATLANTIC HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 1998 AND 1997
The accompanying notes are an integral part of the consolidated financial statements.
TRANSATLANTIC HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
The accompanying notes are an integral part of the consolidated financial statements.
TRANSATLANTIC HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
The accompanying notes are an integral part of the consolidated financial statements.
TRANSATLANTIC HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
The accompanying notes are an integral part of the consolidated financial statements.
TRANSATLANTIC HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
The accompanying notes are an integral part of the consolidated financial statements.
TRANSATLANTIC HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND NATURE OF OPERATIONS
Transatlantic Holdings, Inc. (the 'Company') is a holding company, incorporated in the state of Delaware, which owns all of the common stock of Transatlantic Reinsurance Company (TRC). TRC owns all of the common stock of Putnam Reinsurance Company (Putnam).
In addition, in the third quarter of 1996, TRC acquired all of the outstanding shares of Trans Re Zurich (TRZ), formerly known as Guardian Ruckversicherungs-Gesellschaft (Guardian Re), an international reinsurance company based in Zurich, Switzerland, for approximately $105 million in cash. The acquisition was accounted for as a purchase. Accordingly, TRZ's results for the second half of 1996 and thereafter are included in the consolidated results of the Company. This acquisition has not had a material effect on financial position or net income.
Transatlantic Holdings, Inc. and subsidiaries (TRH), through its operating subsidiaries TRC, TRZ and Putnam, offers reinsurance capacity for a full range of property and casualty products to insurers and reinsurers on a treaty and facultative basis, with an emphasis on specialty classes. Including domestic as well as international risks, TRH's principal lines of business are general liability (including directors' and officers' liability and other professional liability), automobile liability (including nonstandard risks), medical malpractice and marine and aviation in the casualty lines, and fire and allied lines in the property lines (which include property catastrophe risks). Casualty lines represent 71.0%, 67.1% and 66.5% of net premiums written in 1998, 1997 and 1996, respectively. The balance represents property lines.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) BASIS OF PRESENTATION AND PRINCIPLES OF CONSOLIDATION: The accompanying consolidated financial statements have been prepared on the basis of generally accepted accounting principles (GAAP). Certain reclassifications have been made to conform prior years' presentations with 1998.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
These consolidated financial statements include the accounts of the Company and its subsidiaries. All material intercompany accounts and transactions have been eliminated.
(b) INVESTMENTS: Bonds are classified as held-to-maturity and carried at amortized cost if TRH has the positive intent and ability to hold each of these securities to maturity. The balance of TRH's bonds are classified as available-for-sale and carried at market value. Common and nonredeemable preferred stocks are carried principally at market value. Market values for fixed maturity securities and equities are generally based upon quoted market prices. For certain fixed maturity securities for which market prices were not readily available, market values were estimated using values obtained from independent pricing services. Other invested assets consist primarily of investments in partnerships and other investments which are carried primarily at market value. A portion of other invested assets consists of a short-term bond fund managed by an American International Group, Inc. (AIG, and collectively, with its subsidiaries, the AIG Group) subsidiary. (See Note 10.) Short-term investments are carried at cost, which approximates market value.
Realized gains or losses on the sale of investments are determined on the basis of specific identification. Changes in unrealized appreciation (depreciation) of bonds available for sale, equity investments and other invested assets are charged or credited, net of deferred income taxes, directly to accumulated other comprehensive income (See Note 7), a component of stockholders' equity. Investment income is recorded as earned. Amortization of bond premium and the accrual of bond discount are charged or credited to net investment income.
TRANSATLANTIC HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(c) CASH EQUIVALENTS: A portion of cash equivalents consists of a money market fund managed by an AIG subsidiary. (See Note 10.)
(d) DEFERRED ACQUISITION COSTS: Acquisition costs, consisting primarily of net commissions incurred on business conducted through reinsurance contracts or certificates, are deferred, and then amortized over the period in which the related premiums are earned, generally one year. Anticipated losses and loss adjustment expenses and estimated remaining costs of servicing the contracts are considered in determining acquisition costs to be deferred. Anticipated investment income is not considered in the deferral of acquisition costs.
(e) LOSSES AND LOSS ADJUSTMENT EXPENSES: Losses and loss adjustment expenses, net of related reinsurance recoverable, are charged to income as incurred. Unpaid losses and loss adjustment expenses are principally based on reports and individual case estimates received from ceding companies. An amount is included for losses and loss adjustment expenses incurred but not reported (IBNR) on the basis of past experience. The methods of making such estimates and for establishing the resulting reserves are continually reviewed and updated, and any adjustments resulting therefrom are reflected in income currently. TRH does not discount its unpaid losses and loss adjustment expenses.
Unpaid losses and loss adjustment expenses include certain amounts for the reinsurance of risks related to environmental impairment and asbestos-related illnesses. The majority of TRH's environmental and asbestos-related liabilities arise from contracts entered into after 1984. These obligations generally arose from contracts underwritten specifically as environmental or asbestos-related coverages rather than from standard general liability coverages where the environmental or asbestos-related liabilities were neither clearly defined nor specifically excluded. The reserves carried at December 31, 1998 for such claims, including IBNR, are based upon known facts and current law. However, significant uncertainty exists as, among other things, there are inconsistent court resolutions with respect to underlying policy intent and coverage and uncertainties as to the allocation of responsibility for resultant damages. Further, there is always the threat of changes in statutes, laws, regulations and other factors that could have a material effect on these liabilities and, accordingly, future earnings.
(f) UNEARNED PREMIUMS: Unearned premiums represent the portion of gross premiums written which is applicable to the unexpired terms of reinsurance contracts or certificates in force. Accordingly, premiums written are taken into income as earned. Unearned premiums are calculated principally by the monthly pro rata method or are based on reports received from ceding companies. In the Consolidated Statements of Operations, the change in unearned premiums is presented net of the change in prepaid reinsurance premiums.
(g) DEFERRED INCOME TAXES: Deferred income taxes are provided for the expected tax effect of temporary differences between the amounts of assets and liabilities used for financial reporting purposes and the amounts used in tax returns.
(h) REINSURANCE DEPOSITS: Amounts received pursuant to reinsurance contracts that are not expected to indemnify the ceding company against loss or liability are recorded as deposits and included in the Consolidated Balance Sheet as 'reinsurance balances payable.' These deposits are treated as financing transactions and are credited with interest according to contract terms.
(i) CURRENCY TRANSLATION: Assets and liabilities denominated in foreign currencies are translated into U.S. dollars at year-end exchange rates. Income and expense accounts are translated at average exchange rates for the year. The resulting net unrealized currency translation gain (loss) for functional currencies is reflected in accumulated other comprehensive income, a component of stockholders' equity.
Transaction gains and losses on assets and liabilities denominated in foreign currencies which are not designated as functional currencies are reflected in results of operations during the period in which they occur.
TRANSATLANTIC HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(j) NET INCOME PER COMMON SHARE: Net income per common share has been computed in the following table in accordance with Statement of Financial Accounting Standards No. 128, 'Earnings Per Share' (See Note 2(k)), based upon weighted average common shares outstanding. Share amounts have been retroactively adjusted to reflect a 3-for-2 split of the common stock in the form of a 50% stock dividend, paid in July 1997.
(k) ACCOUNTING STANDARDS:
In October 1995, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 123, 'Accounting for Stock-Based Compensation.' This statement established new financial accounting and reporting standards for stock-based employee compensation plans, including stock option and stock purchase plans. Compensation resulting from the award of stock-based compensation must be determined based on the fair value of consideration received or fair value of the equity instrument issued, whichever is more reliably measurable. Such compensation expense, net of income taxes, may be recognized in the Statement of Operations over the service period of the employee (generally the vesting period). In lieu of recording such compensation expense, entities are permitted to disclose its pro forma impact, net of income taxes, on reported net income and earnings per share. Entities choosing such disclosure will continue to measure compensation expense from stock-based compensation in the Statement of Operations based on the intrinsic value method prescribed in Accounting Principles Board (APB) No. 25, 'Accounting for Stock Issued to Employees.'
In accordance with the standard, TRH adopted SFAS No. 123 beginning with the 1996 annual financial statements and chose the pro forma disclosure option of implementation. (See Note 9.)
In June 1996, the FASB issued SFAS No. 125, 'Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.' This statement provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities. In addition, it provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings.
SFAS No. 125 was effective as of January 1, 1997 and was to be applied prospectively. However, SFAS No. 127, 'Deferral of the Effective Date of Certain Provisions of SFAS No. 125,' deferred for one year the effective date of certain provisions of SFAS No. 125 which affect repurchase agreements, dollar-rolls, securities lending and similar transactions. The implementation of these standards, which occurred on their respective effective dates, did not have a material impact on results of operations, financial position or cash flows.
TRANSATLANTIC HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In February 1997, the FASB issued SFAS No. 128, 'Earnings Per Share.' As compared to the prior standard, SFAS No. 128 simplifies computational guidelines, revises disclosure requirements and increases earnings per share (EPS) comparability on an international basis.
Basic EPS, which is calculated by dividing net income by the weighted average number of common shares outstanding, replaced primary EPS from the prior standard. For all periods reported by TRH prior to implementation of the standard, basic EPS would have been the same as primary EPS, since the impact of the Company's common stock equivalents (principally stock options) for those periods did not reach the significance threshold prescribed to require adjustment under the prior standard. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. Diluted EPS is computed similarly to fully diluted EPS from the prior standard.
For all entities with complex capital structures, basic and diluted EPS must be shown on the face of the income statement with equal prominence. In addition, a reconciliation of the numerator and denominator from the basic EPS computation to the diluted EPS computation is required. (See Note 2(j).)
Pursuant to the standard, TRH adopted SFAS No. 128 for the 1997 annual financial statements and restated all prior period EPS data presented.
Also in February 1997, the Securities and Exchange Commission (SEC) issued Financial Reporting Release (FRR) No. 48, 'Disclosure of Accounting Policies for Derivative Financial Instruments and Derivative Commodity Instruments and Disclosure of Quantitative and Qualitative Information about Market Risk Inherent in Derivative Financial Instruments, Other Financial Instruments, and Derivative Commodity Instruments.'
FRR No. 48 amends rules and forms for registrants and requires clarification and expansion of existing disclosures for derivative financial instruments, other financial instruments and derivative commodity instruments, as defined therein. The amendments require enhanced disclosure with respect to these derivative instruments in the notes to financial statements. During the three year period ending December 31, 1998, TRH has had no derivative instruments.
Additionally, the amendments expand existing disclosure requirements to include quantitative and qualitative discussions in Management's Discussion and Analysis of Financial Condition and Results of Operations (Management's Discussion) with respect to market risk inherent in market risk sensitive instruments such as equity and fixed maturity securities, as well as derivative instruments. These amendments are designed to provide additional information about market risk sensitive instruments which investors can use to better understand and evaluate market risk exposures of registrants. For TRH, these disclosures are included for 1998 in Management's Discussion which accompanies these financial statements and related notes.
In June 1997, the FASB adopted SFAS No. 130, 'Reporting Comprehensive Income.' This statement established standards for reporting and display of comprehensive income and its components (revenues, expenses, gains and losses) in a full set of general-purpose financial statements. Comprehensive income is defined as the change in stockholders' equity during a period from transactions and other events and circumstances from non-owner sources and includes net income and all changes in stockholders' equity except those resulting from investments by owners and distribution to owners.
This standard requires that an enterprise (a) classify items of other comprehensive income by their nature in a financial statement and (b) display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of a statement of financial position.
TRANSATLANTIC HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In accordance with the standard, TRH adopted SFAS No. 130 in 1998. Comparable data from prior years are presented in conformity with the new standard.
Also in June 1997, the FASB adopted SFAS No. 131, 'Disclosure about Segments of an Enterprise and Related Information.' This statement establishes standards for the way that public business enterprises report information about operating segments in annual and interim financial statements and requires presentation of a measure of profit or loss, certain specific revenue and expense items and segment assets. It also establishes standards for related disclosures about products and services, geographic areas and major customers, superseding most of SFAS No. 14, 'Financial Reporting for Segments of a Business Enterprise.'
SFAS No. 131 requires that a public business enterprise report financial and descriptive information about its reportable operating segments. Generally, financial information is required to be reported on the basis that is used internally for evaluating segment performance and deciding how to allocate resources to segments. The enterprise must report information about the revenues derived, countries in which it earns revenues and holds assets and major customers regardless of whether that information is used in making operating decisions. However, this statement does not require an enterprise to report information that is not prepared for internal use if reporting it would be impracticable.
SFAS No. 131 is effective for TRH's 1998 financial statements. This statement need not be applied to interim financial statements in the initial year of its application, but comparative information for interim periods in the initial year of application is to be reported in financial statements for interim periods in the second year of application. TRH has adopted this standard for the 1998 annual financial statements and has provided comparable prior year data.
In June 1998, the FASB issued SFAS No. 133, 'Accounting for Derivative Instruments and Hedging Activities.' This statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. All derivatives must be recognized as either assets or liabilities in the balance sheet and measured at fair value. The accounting recognition for the change in the fair value of a derivative depends on a number of factors, including the intended use of the derivative. SFAS No. 133 is effective for TRH as of January 1, 2000 and may not be applied retroactively. TRH presently has no derivative instruments.
In October 1998, the American Institute of Certified Public Accountants (AICPA) issued Statement of Position (SOP) 98-7, 'Deposit Accounting: Accounting for Insurance and Reinsurance Contracts That Do Not Transfer Insurance Risk.' This statement provides guidance on how to account for insurance and reinsurance contracts that do not transfer both required elements of insurance risk (i.e., underwriting risk and timing risk). SOP 98-7 will be effective for TRH on January 1, 2000. Restatement of previously issued annual financial statements is not permitted. Management believes that the impact of applying this statement will not be material to results of operations, financial position or cash flows.
TRANSATLANTIC HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. INVESTMENTS
(a) STATUTORY DEPOSITS: Investments, the substantial majority of which are bonds and common stocks available for sale, were deposited with governmental authorities as required by law and amounted to approximately $122,000,000 and $123,000,000 at December 31, 1998 and 1997, respectively.
(b) NET INVESTMENT INCOME: An analysis of net investment income of TRH follows:
(c) INVESTMENT GAINS AND LOSSES: The realized net capital gains and change in net unrealized appreciation (depreciation) of investments are summarized as follows:
- ------------
* Before deferred income tax effect.
TRANSATLANTIC HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. INVESTMENTS (CONTINUED)
(d) FIXED MATURITIES: The amortized cost and market value of bonds at December 31, 1998 and 1997 are summarized as follows:
TRANSATLANTIC HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. INVESTMENTS (CONTINUED)
The amortized cost and market value of bonds at December 31, 1998 by contractual maturity, are summarized below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Investments in fixed maturities exclude short-term investments.
Gross gains of $7,625,000, $2,930,000 and $6,771,000 and gross losses of $647,000, $1,325,000 and $6,903,000 were realized on sales of investments in fixed maturities available for sale in 1998, 1997 and 1996, respectively.
(e) EQUITIES: Gross gains of $122,685,000, $35,507,000 and $23,621,000 and gross losses of $10,874,000, $6,132,000 and $5,398,000 were realized on sales of equities in 1998, 1997 and 1996, respectively. At December 31, 1998 and 1997, net unrealized appreciation of equities (before applicable income taxes) included gross gains of $160,160,000 and $171,130,000 and gross losses of $6,199,000 and $1,719,000, respectively.
4. FEDERAL AND FOREIGN INCOME TAXES
(a) The Company files a U.S. consolidated federal income tax return with its domestic subsidiaries, TRC and Putnam. TRC will include as part of its taxable income those items of income of the non-U.S. subsidiary, TRZ, which are subject to U.S. income tax currently, pursuant to Subpart F income rules of the Internal Revenue Code, and included, as appropriate, in the consolidated federal income tax return.
TRANSATLANTIC HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
4. FEDERAL AND FOREIGN INCOME TAXES (CONTINUED) The U.S. Federal Income tax rate is 35% for 1998, 1997 and 1996. Actual tax expense on income before income taxes differs from the 'expected' amount computed by applying the U.S. Federal income tax rate because of the following:
(b) The components of the net deferred income tax asset at December 31, 1998 and 1997 were as follows:
No valuation allowance has been recorded.
(c) Income tax payments by TRH totaled $110,884,000, $48,744,000 and $39,939,000 in 1998, 1997 and 1996, respectively.
TRANSATLANTIC HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
5. LIABILITY FOR UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
Activity in the liability for unpaid losses and loss adjustment expenses is summarized as follows:
As a result of net decreases in estimates of losses occurring in prior years, net losses and loss adjustment expenses were reduced by $59.5 million in 1998. Significant favorable development was recorded in 1998 on losses occurring in years subsequent to 1986 in the other liability line, in 1996 and 1997 in the medical malpractice line and in 1993 through 1996 in the fire and allied lines. These reductions to incurred losses were partially offset by adverse development in 1998 on losses occurring in 1996 and 1997 in the ocean marine line, prior to 1984 in the other liability line and in 1997 in the fire line.
As a result of net decreases in estimates of losses occurring in prior years, net losses and loss adjustment expenses were reduced by $14.6 million in 1997. Significant favorable development was recorded in 1997 on losses occurring in years subsequent to 1986 in the other liability line, in 1996 in the medical malpractice line and in 1995 and 1994 in certain property lines. These reductions to incurred losses were partially offset by adverse development in 1997 on losses occurring in 1996 in aircraft and surety lines, in 1995 and 1994 in the medical malpractice line and in 1983 and prior in the other liability line.
As a result of net decreases in estimates of losses occurring in prior years, net losses and loss adjustment expenses incurred were reduced by $7.7 million in 1996. In the other liability line, favorable development on losses occurring in more recent years was offset by adverse development in 1984 and prior years. In addition, in more recent years, favorable development, particularly in the fire, allied line and aircraft lines was partially offset by adverse development in the automobile liability line.
TRANSATLANTIC HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
6. COMMON STOCK
Common stock activity for each of the three years in the period ended December 31, 1998 was as follows:
As a result of a common stock split in the form of a 50% stock dividend, common stock increased and additional paid-in capital decreased by $11.5 million in 1997. This stock split was paid on July 18, 1997 to holders of record on June 27, 1997.
7. ACCUMULATED OTHER COMPREHENSIVE INCOME
The components of accumulated other comprehensive income and changes in such amounts between years are as follows:
8. PENSION, SAVINGS AND STOCK PURCHASE PLANS
TRH's employees participate in benefit plans administered by AIG (See Note 9) including a noncontributory defined benefit pension plan and a voluntary savings plan (a 401(k) plan) which provides for certain matching contributions. These plans cover a substantial majority of TRH's employees. Certain of these plans do not separately identify plan benefits and plan assets attributable to employees of participating companies. In the opinion of management, no material additional liability would accrue to TRH were such plan benefits and plan assets identifiable.
Under TRH's 1990 Employee Stock Purchase Plan, as amended, all full time employees with at least one year of employment with the Company or any of its subsidiaries are eligible to receive privileges to purchase shares of the Company's common stock at a price which is 85% of the fair market value of such stock on the date of subscription or the date of grant of the purchase privilege, whichever is greater. An aggregate of 750,000 shares of common stock has been authorized for subscription and 7,115 shares were purchased under the plan in 1998.
The charges made to operations for these plans for 1998, 1997 and 1996 were $676,000, $732,000 and $678,000, respectively.
TRANSATLANTIC HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
9. STOCK OPTION PLANS
In 1995, the Company's Board of Directors adopted, and the stockholders approved, the '1995 Stock Option Plan' (the 1995 Plan). This plan, as amended, provides that options may be granted to certain key employees and non-employee directors to purchase a maximum of 1,500,000 shares of the Company's common stock at prices not less than their fair market value at the date of grant. At December 31, 1998, 816,611 shares were reserved for future grants under the 1995 Plan. Options granted under the plan may be used to purchase the Company's common stock at the fair market value of each share at the date of grant. The Company also maintains the 'Transatlantic Holdings, Inc. 1990 Stock Option Plan' (the 1990 Plan) which operates under substantially the same terms as the 1995 Plan. The 1995 Plan and the 1990 Plan are together hereinafter referred to as the Company Plans.
In each of 1994 and 1992, the Stock Option and Purchase Plan Committee granted 30,000 options to certain non-employee directors of the Company who are also directors, officers and employees of AIG. These options may be used to purchase shares of the Company's common stock at $34.00 per share and $35.00 per share for the 1994 and 1992 options, respectively, representing the fair market value of a share of the Company's common stock at the date of grant. Such options were granted outside of, but on substantially the same terms and conditions as, the 1990 Plan. As of December 31, 1998, all of these options were exercisable as none have been exercised or forfeited. The impact of the above options on the financial statements is not material.
Each of the above plans provide that 25% of the options granted become exercisable on the anniversary date of the grant in each of the four years following the grant and expire 10 years from the date of grant. No further options can be granted under the 1990 Plan, although options outstanding continue in force until exercise, expiration or forfeiture.
A summary of the status of the Company Plans as of December 31, 1998, 1997 and 1996 and changes during the years ended on those dates is presented below:
The weighted average fair value of each option grant is estimated on the date of grant using the 'Binomial Option Price Model' with the following weighted average assumptions used for grants in 1998, 1997 and 1996, respectively: expected volatility of 18.0%, 15.0% and 22.5%; risk-free interest rates of 4.6%, 5.8% and 6.2%; and expected lives of six years for each grant. An increasing dividend schedule is used in the binomial model based on historical experience.
TRANSATLANTIC HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
9. STOCK OPTION PLANS (CONTINUED)
The following table summarizes information about the Company Plans' outstanding and exercisable options at December 31, 1998:
The Company accounts for its stock options based on the intrinsic value method prescribed in APB No. 25 and related interpretations, as permitted under SFAS No. 123. Had compensation cost been charged to earnings in accordance with the fair value method discussed in SFAS No. 123, the Company's net income and net income per share (on a pro forma basis) would have been as follows:
The effects of applying SFAS No. 123 in the immediately preceding pro forma data may not be indicative of future amounts as this standard does not apply to options granted prior to 1995. Additional grants in future years are anticipated.
10. RELATED PARTY TRANSACTIONS
In April 1996, AIG increased its beneficial ownership of the Company's outstanding common stock from 48% to 49%. In August 1998, AIG acquired additional shares, placing its beneficial ownership interest over 50%. As of December 31, 1998, AIG beneficially owned approximately 52% of the Company's outstanding shares.
TRH has service and expense agreements and certain other agreements with the AIG Group which provide for the reimbursement to the AIG Group of certain administrative and operating expenses which include, but are not limited to, investment advisory and cash management services, office space and payroll processing services. In 1998, 1997 and 1996, $9,800,000, $9,300,000 and $8,500,000, respectively, of operating and investment expenses relate to services and expenses provided by the AIG Group under these agreements.
Approximately $167 million (11%), $181 million (12%) and $232 million (18%) of gross premiums written by TRH in 1998, 1997 and 1996, respectively, were attributable to reinsurance purchased by the AIG Group, for the production of which TRH paid ceding commissions to the AIG Group of $31
TRANSATLANTIC HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
10. RELATED PARTY TRANSACTIONS (CONTINUED)
million, $32 million and $33 million, respectively, in such years. (See Note 12 for information relating to reinsurance ceded to related parties.)
11. DIVIDEND RESTRICTION AND STATUTORY FINANCIAL DATA
The payment of dividends by the Company is dependent on the ability of its subsidiaries to pay dividends. The payment of dividends by TRC and its wholly-owned subsidiaries, TRZ and Putnam, is restricted by insurance regulations. Under New York insurance law, TRC and Putnam may pay dividends only out of their statutory earned surplus. Generally, the maximum amount of dividends that a company may pay without regulatory approval in any twelve-month period is the lesser of adjusted net investment income or 10% of statutory policyholders' surplus as of the end of the most recently reported quarter unless the New York Insurance Department, upon prior application, approves a greater dividend distribution. Adjusted net investment income is defined for this purpose to include net investment income for the twelve months immediately preceding the declaration or distribution of the current dividend increased by the excess, if any, of net investment income over dividends declared or distributed during the period commencing thirty-six months prior to the declaration or distribution of the current dividend and ending twelve months prior thereto. The statutory surplus of TRC includes the statutory surplus of Putnam since all the capital stock of Putnam is owned by TRC. At December 31, 1998, TRC had statutory earned surplus of $789,736,000 and, in 1999, could pay dividends of approximately $134,366,000 without such regulatory approval.
Statutory surplus and net income as reported to the New York Insurance Department were as follows:
TRC and Putnam each prepare statutory financial statements in accordance with accounting practices prescribed or permitted by New York -- their state of domicile. Prescribed statutory accounting practices are discussed in a variety of publications of the National Association of Insurance Commissioners (NAIC), as well as in state laws, regulations and general administrative rules. Permitted statutory accounting practices encompass all accounting practices not so prescribed. All material statutory accounting practices of TRC and Putnam are prescribed in the authoritative literature described above.
12. REINSURANCE CEDED
In the normal course of business, TRH purchases reinsurance from its retrocessionnaires to reduce the effect of individual or aggregate losses and to allow increased gross premium writings and afford greater risk capacity without necessarily requiring additional capital.
TRH's ceded reinsurance agreements consist of pro rata and excess-of-loss contracts. Under pro rata reinsurance, TRH and its retrocessionnaires share premiums, losses and expenses in an agreed upon proportion. For consideration, generally based on a percentage of premiums of the individual policy or policies subject to the reinsurance agreement, excess-of-loss contracts provide reimbursement to TRH for losses in excess of a predetermined amount up to a predetermined limit.
TRANSATLANTIC HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
12. REINSURANCE CEDED (CONTINUED)
Premiums written and earned and losses and loss adjustment expenses incurred are comprised as follows:
Amounts recoverable from retrocessionnaires are recognized in a manner consistent with the claims liabilities associated with the retrocession and are presented on the balance sheet as reinsurance recoverable on paid and unpaid losses and loss adjustment expenses. Such balances at December 31, 1998 and 1997 are comprised as follows:
Ceded reinsurance arrangements do not relieve TRH from its obligations to the insurers and reinsurers from whom it assumes business. The failure of retrocessionnaires to honor their obligation could result in losses to TRH; consequently, an allowance has been established for estimated unrecoverable reinsurance on paid and unpaid losses totaling $13.0 million and $13.3 million in 1998 and 1997, respectively. TRH evaluates the financial condition of its retrocessionnaires through a security committee. With respect to reinsurance recoverable on paid and unpaid losses and prepaid reinsurance premiums, TRH holds substantial amounts of funds and letters of credit to collateralize these amounts. Such funds and letters of credit can be drawn on for amounts remaining unpaid beyond contract terms. No uncollateralized amounts recoverable from a single retrocessionnaire, other than amounts due from AIG affiliates, are considered material to the financial position of TRH.
TRANSATLANTIC HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
13. SEGMENT INFORMATION
TRH conducts its business and assesses performance through segments organized along geographic lines. Financial data from offices in London, Paris and Zurich are reported in the aggregate as Europe and considered as one segment due to operational and regional similarities. Data from offices in the Americas, other than those in the United States which underwrite primarily domestic business, and from offices in the Asia Pacific region are grouped as International -- Other and represent the aggregation of non-material segments. In each segment, property and casualty reinsurance is provided to insurers and reinsurers on a treaty and facultative basis, through brokers or directly to ceding companies.
A significant portion of assets and liabilities of TRH's international operations relate to the countries where ceding companies and reinsurers are located. Most investments are located in the country of domicile of these operations. In addition to licensing requirements, TRH's international operations are regulated in various jurisdictions with respect to currency, amount and type of security deposits, amount and type of reserves and amount and type of local investment. Regulations governing constitution of technical reserves and remittance balances in some countries may hinder remittance of profits and repatriation of assets.
While the great majority of premium revenues and assets relate to the regions where particular offices are located, a portion of such amounts are derived from other regions of the world. In addition, approximately 19% of consolidated revenues, with a significant portion in each segment, were obtained through a large international reinsurance broker.
The following table is a summary of financial data by segment:
- ------------ (1) Revenues represent the sum of net premiums earned, net investment income and realized net capital gains.
(2) Domestic revenues and income before income taxes include realized net capital gains of $118,601, $31,727 and $15,913 in 1998, 1997 and 1996, respectively. Realized net capital gains for other segments in each of the years presented is not material.
(3) Includes revenues from the London, England office of $331,944, $298,523 and $279,617 in 1998, 1997 and 1996, respectively, and revenues from the Zurich, Switzerland office of $155,628, $186,780 and $87,954 in 1998, 1997 and 1996, respectively.
(4) As of December 31.
TRANSATLANTIC HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
13. SEGMENT INFORMATION (CONTINUED)
Net premiums earned by major product grouping are as follows:
- ------------ * A significant portion of this product grouping includes more complex risks such as professional liability (other than medical malpractice), directors' and officers' liability, errors and omissions and environmental impairment liability.
TRANSATLANTIC HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
14. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
The following is a summary of unaudited quarterly financial data for each of the years ended December 31, 1998 and 1997. However, in the opinion of management, all adjustments, consisting of normal recurring accruals, necessary to present fairly the results of operations for such periods have been made.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
There have been no changes in nor any disagreements with accountants on accounting and financial disclosure within the twenty-four months ended December 31, 1998.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information required by this Item concerning directors of the Company is included in the Company's Proxy Statement for the 1999 Annual Meeting of Stockholders, filed with the Securities and Exchange Commission within 120 days after the end of the Company's fiscal year (the '1999 Proxy Statement'), in the section captioned 'Election of Directors,' and such information is incorporated herein by reference. Information required by this Item concerning the executive officers of the Company is included in Part I of this Annual Report on Form 10-K under the section captioned 'Directors and Executive Officers of the Registrant.' Information required by this Item concerning compliance with Section 16(a) of the Securities Exchange Act of 1934, as amended, is included in the 1999 Proxy Statement under the caption 'Election of Directors: `Ownership of Certain Securities,' ' and such information is incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Information required by this Item is included in the 1999 Proxy Statement in the sections captioned 'Election of Directors: `Compensation of Directors and Executive Officers,' `Compensation Committee Interlocks and Insider Participation' and `Pension Benefits,' ' and such information is incorporated herein by reference. The sections of the 1999 Proxy Statement captioned 'Election of Directors: `Committee Reports on Executive Compensation' and `Performance Graph' ' are not incorporated by reference herein.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information required by this Item is included in the 1999 Proxy Statement in the sections captioned 'Beneficial Ownership' and 'Election of Directors: `Ownership of Certain Securities,' ' and such information is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information required by this Item is included in the 1999 Proxy Statement in the sections captioned 'Election of Directors: `Compensation Committee Interlocks and Insider Participation,' `Relationship with AIG,' `AIG Group Reinsurance,' `Certain Transactions with the AIG Group' and `Relationship with SICO and Starr,' ' and such information is incorporated herein by reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Financial Statements and Exhibits
1. Financial Statements and Schedules
See accompanying Index to Consolidated Financial Statements in Item 8. Schedules not included in the accompanying index have been omitted because they are not applicable.
2. Exhibits
3.2 -- Amended and Restated By-Laws, as of March 25, 1999.
21.1 -- Subsidiaries of Registrant.
23.1 -- Consent of PricewaterhouseCoopers LLP.
27.1 -- Financial Data Schedule.
See accompanying Exhibit Index for additional Exhibits incorporated by reference.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the last quarter of 1998.
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.
TRANSATLANTIC HOLDINGS, INC.
By: /s/ ROBERT F. ORLICH ................................. Robert F. Orlich Title: President and Chief Executive Officer
March 25, 1999
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.
SCHEDULE I
TRANSATLANTIC HOLDINGS, INC. AND SUBSIDIARIES SUMMARY OF INVESTMENTS -- OTHER THAN INVESTMENTS IN RELATED PARTIES AS OF DECEMBER 31, 1998
- ------------ * Investments in fixed maturities are shown at amortized cost.
S-1
SCHEDULE II
TRANSATLANTIC HOLDINGS, INC. AND SUBSIDIARIES CONDENSED FINANCIAL INFORMATION OF REGISTRANT BALANCE SHEETS (PARENT COMPANY ONLY) AS OF DECEMBER 31, 1998 AND 1997
See Notes to Condensed Financial Information of Registrant -- (Parent Company Only)
S-2
SCHEDULE II
TRANSATLANTIC HOLDINGS, INC. AND SUBSIDIARIES CONDENSED FINANCIAL INFORMATION OF REGISTRANT -- (CONTINUED) STATEMENTS OF OPERATIONS (PARENT COMPANY ONLY) FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
See Notes to Condensed Financial Information of Registrant -- (Parent Company Only)
S-3
SCHEDULE II
TRANSATLANTIC HOLDINGS, INC. AND SUBSIDIARIES CONDENSED FINANCIAL INFORMATION OF REGISTRANT -- (CONTINUED) STATEMENTS OF CASH FLOWS (PARENT COMPANY ONLY) FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- ------------ Notes to Condensed Financial Information of Registrant -- (Parent Company Only)
(1) The condensed financial information of registrant should be read in conjunction with the Consolidated Financial Statements and Notes to Consolidated Financial Statements included elsewhere herein.
(2) Investment in subsidiaries is reflected on the equity method.
S-4
SCHEDULE III
TRANSATLANTIC HOLDINGS, INC. AND SUBSIDIARIES SUPPLEMENTARY INSURANCE INFORMATION AS OF DECEMBER 31, 1998, 1997 AND 1996 AND FOR THE YEARS THEN ENDED
S-5
SCHEDULE IV
TRANSATLANTIC HOLDINGS, INC. AND SUBSIDIARIES REINSURANCE FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
S-6
SCHEDULE VI
TRANSATLANTIC HOLDINGS, INC. AND SUBSIDIARIES SUPPLEMENTARY INFORMATION CONCERNING PROPERTY/CASUALTY INSURANCE OPERATIONS AS OF DECEMBER 31, 1998, 1997 AND 1996 AND FOR THE YEARS THEN ENDED
S-7
EXHIBIT INDEX
- ------------ * Management compensation plan.