ITEM 1 BUSINESS
Life Re Corporation ("Life Re" or the "Company"), through its principal wholly-owned subsidiary, Life Reassurance Corporation of America ("Life Reassurance"), provides ordinary and group life reinsurance in the United States. Life Reassurance has specialized in providing life reinsurance since its formation in 1967.
Pursuant to an Agreement and Plan of Merger, dated as of July 27, 1998 (the "Merger Agreement"), by and among Swiss Reinsurance Company, a Swiss corporation ("Swiss Re"), SRC Acquisition Corp., a Delaware corporation and a wholly owned subsidiary of Swiss Re ("Sub"), Swiss Re America Holding Corporation, a Delaware corporation and a wholly owned subsidiary of Swiss Re ("Holding") and the Company, on December 1, 1998, Sub was merged with and into the Company (the "Merger"), with the Company continuing as the surviving corporation and became a wholly owned subsidiary of Swiss Re and Holding, and each outstanding share of common stock, par value $.001 per share, of the Company (the "Common Stock"), other than shares held by the Company in its treasury, Swiss Re, Holding, the Sub or any other wholly owned subsidiary of Swiss Re, and shares held by the stockholders, if any, who properly exercised their appraisal rights under Delaware law, was converted into the right to receive $95.00 in cash.
Life Re serves as a holding company for all of the common stock of TexasRe Life Insurance Company ("TexasRe"), which in turn owns all of the common stock of Life Reassurance.
Life Re's two core lines of business are traditional life reinsurance, which involves the transfer of mortality risks on new sales from primary (or ceding) insurers of ordinary and group life insurance to the Company, and Administrative Reinsurance(SM), which involves the acquisition of blocks of life insurance in force and, frequently, the assumption of administrative responsibility by the Company.
In July 1995, Life Reassurance acquired all of the common stock of John Deere Life Insurance Company (since renamed Reassure America Life Insurance Company or "REALIC") from two subsidiaries of Deere & Company for an adjusted purchase price of $33.3 million, to serve as the Company's initial platform for Administrative Reinsurance(SM). With the acquisition of REALIC, the Company obtained primary insurance licenses and began outsourcing administrative services for primary insurance in force on a variable cost basis. During 1998 the Company acquired Mission Life Insurance Company ("Mission Life"), Lincoln Liberty Life Insurance Company ("Lincoln Liberty Life"), First Delaware Life Insurance Company ("First Delaware Life"), Atlas Life Insurance Company ("Atlas Life"), Capitol Bankers Life Insurance Company ("Capitol Bankers Life"), Aristar Life Insurance Company ("Aristar Life") and First Capital Life Insurance Company of Louisiana ("First Capital Life"). In addition, during 1997 the Company entered into reinsurance agreements covering in force business of Allianz Life Insurance Company of North America ("Allianz") and UNUM Life Insurance Company of America ("UNUM") and acquired 79% of AML Acquisition Company, the owner of American Merchants Life Insurance Company ("AML").
TexasRe, Life Reassurance, REALIC, AML, Mission Life, Capitol Bankers Life and First Capital Life are sometimes referred to herein collectively as the "Subsidiaries."
In 1995, Life Re formed a Bermuda subsidiary, Life Re International, Ltd., for the reinsurance of domestic and internationally generated life and health insurance risks. Currently, Life Re International, Ltd. has minimal business in force.
During 1997, Life Re withdrew from the group accident and health and special risk reinsurance business.
On March 17, 1998, the Company completed two separate public offerings (together, the "Offerings") in which it sold 3,500,000 shares of common stock and 2,070,000 6.0% Adjustable Conversion-rate Equity Security Units (the "Units") issued through Life Re Capital Trust II, a subsidiary of Life Re. The Units consist of a stock purchase contract and Quarterly Income Preferred Securities. Net proceeds from the Offerings were $352.3 million of which $207.0 million was contributed to the Subsidiaries.
BUSINESS WRITTEN
General
The business of reinsurance generally consists of reinsurers, such as Life Re, which enter into contractual arrangements (treaties) with primary insurers (ceding companies) whereby the reinsurer agrees to indemnify the ceding company for all or a portion of the risks associated with the underlying insurance policy in exchange for a reinsurance premium payable to the reinsurer. Reinsurers also may enter into retrocessional reinsurance arrangements with other reinsurers, which operate in a manner similar to the underlying reinsurance arrangement described above. Under retrocessional reinsurance arrangements, the reinsurer shifts a portion of the risk associated with the underlying insurance policy to the retrocessionaires.
Reinsurance agreements may be written on an automatic treaty basis or facultative basis, and reinsurance may be marketed directly by the reinsurer or through reinsurance intermediaries or brokers. An automatic treaty provides for a ceding company to cede contractually agreed-upon risks on specific blocks of business to a reinsurer and binds that reinsurer without obtaining further approval from that reinsurer. Facultative reinsurance is the reinsurance of individual risks whereby a reinsurer has the opportunity to analyze and separately underwrite a risk prior to agreeing to accept the risk. In addition, both automatic treaty and facultative reinsurance may be written on either a quota share basis (a percentage of each risk in the reinsured class of risk is assumed by the reinsurer from the ceding company with premiums proportional to such assumed risk being paid to reinsurers) or an excess of loss basis (reinsurers indemnify the ceding company up to a contractually-specified amount for a portion of claims exceeding a specified retention amount in consideration of non-proportional premiums being paid).
Life Re's major lines of business are traditional life reinsurance, which includes ordinary and group life reinsurance, and Administrative Reinsurance(SM). The Administrative Reinsurance(SM) line of business, which focuses on acquiring and administering primary life insurance in force, includes closed blocks of directly written life insurance, annuities and automobile credit life and disability reinsurance. Life Re's lines of business cover the following risks: (i) mortality and morbidity, (ii) investment, (iii) lapsation, and (iv) expense. Life Re writes reinsurance predominantly on a direct basis with primary life insurance companies. Life Re ceased writing new group accident and health and special risk reinsurance during 1997.
The following table sets forth selected information for the indicated periods concerning Life Re's insurance operations:
DISTRIBUTION OF POLICY REVENUES AND INSURANCE IN FORCE (DOLLARS IN THOUSANDS)
Traditional Life Reinsurance
Life Re's traditional life reinsurance business has two primary components, ordinary life reinsurance and group life reinsurance. The Company provides life reinsurance primarily for mortality risks with respect to both ordinary and group life reinsurance products.
Ordinary life reinsurance generally is the reinsurance of individual term life insurance policies, whole life insurance policies, universal life insurance policies, and joint and survivor insurance policies. Life Re's ordinary life line of business reinsures all of these products.
Substantially all of Life Re's policy revenues with respect to ordinary life reinsurance are written on an automatic treaty basis. Ordinary life reinsurance is written on a facultative basis only in limited circumstances, generally for primary insurers with which Life Re has automatic treaty reinsurance business. Facultative reinsurance is individually underwritten by Life Re for each policy to be reinsured, with the pricing and other terms established at the time the policy is underwritten based upon rates negotiated in advance. Most of Life Re's ordinary life reinsurance business is written on a quota share basis. Life Re generally requires ceding companies to retain at least 10% of every risk, whether the business is written on an excess or quota share basis. Life Re generally limits its own net liability on any one ordinary life risk to $1.0 million. Life Re's reinsurance agreements frequently provide for rights of recapture, which permit the ceding company to increase the amount of liability it retains on the reinsured policies after the policies have remained in force for a designated period of time (generally between ten and twenty years).
Life Re's ordinary life reinsurance agreements typically remain in force for the life of the underlying policies reinsured. Life Re is entitled to renewal policy revenues absent the death of the insured, voluntary surrender or lapse of the policy due to nonpayment of premium or the recapture by the ceding company of the risks reinsured.
The following table sets forth Life Re's net policy revenues on traditional life reinsurance separated between first year business and renewal business for the periods indicated:
DISTRIBUTION OF FIRST YEAR AND RENEWAL POLICY REVENUES FOR TRADITIONAL LIFE REINSURANCE (DOLLARS IN THOUSANDS)
- --------------- (1) First year policy revenues are premiums received within one year of the date of issuance of the underlying policy, whether reinsured under treaties entered into prior to or during the indicated period.
As of December 31, 1998 Life Re reinsured ordinary life insurance business under treaties with approximately 500 ceding companies. In 1998, 64 ceding companies each accounted for at least $1.0 million of ordinary life reinsurance policy revenues and in the aggregate represented approximately 95% of Life Re's ordinary life reinsurance policy revenues. Life Re markets its ordinary life reinsurance to a broad cross section of companies, which vary in size, corporate structure and geographic location. Except for Metropolitan Life Insurance Company which provided approximately $60.9 million of policy revenues in 1998, no ordinary life ceding company accounted for more than 10% of Life Re's policy revenues in 1998.
Life Re reinsures, or retrocedes, portions of certain risks for which it has accepted liability. Life Re's policy is to retain up to $1.0 million of liability on any one life for ordinary life insurance. The next $15.0 million of liability in excess of $1.0 million is retroceded to a pool of ten retrocessionaires. In certain limited circumstances Life Re reinsures policies where the underlying risk exceeds $16.0 million. In such cases, Life Re retrocedes any such risk in excess of $16.0 million on a facultative basis.
Each retrocessionaire in Life Re's current ordinary life pool reinsures a percentage of each risk that is retroceded to the pool. Each of the domestic participants in the pool is rated "A" or better by A.M. Best Company, Inc. ("A.M. Best"). Although the foreign retrocessionaires, which constitute 20% of the pool, are not rated by A.M. Best, each of the foreign retrocessionaires provides Life Re with an irrevocable letter of credit drawn on a U.S. bank or a U.S. branch of a foreign bank in the amount of the reserves held by such retrocessionaire for the benefit of Life Re. If a foreign retrocessionaire were to default on its payments, Life Re could collect such funds by exercising its rights under the applicable letter of credit. To date, Life Re has not experienced any default in connection with its retrocessional arrangements.
Group life reinsurance is the reinsurance of various types of group life policies. These policies generally include employee-employer group term life (representing the majority of such business), voluntary and supplemental term life, association or affinity term life, group universal life and voluntary group universal life. Group life reinsurance generally is written on an annual basis resulting in the terms of such contracts being subject to renegotiation or cancellation each year. Life Re typically reinsures group life clients on an experience rated basis, whereby the ceding company receives a refund of a portion of the profits resulting from favorable claims experience with respect to the underlying policies. Group life reinsurance policy revenues were $17.1 million, $15.2 million and $23.2 million in 1998, 1997 and 1996, respectively. Experience rating refunds amounted to $4.2 million, $0.7 million and $3.1 million for 1998, 1997 and 1996, respectively.
Life Re markets its group life reinsurance to a broad cross section of client entities, which vary in size, corporate structure and geographic location. No group life client accounted for more than 10% of Life Re's policy revenues in 1998.
Life Re's group life retrocessionaire is rated "A" by A.M. Best and to date, Life Re has not experienced any default in connection with its retrocessional arrangements of group life claims. Life Re's retention limit for group life insurance business generally may be in an amount up to $350,000, with amounts in excess thereof being retroceded.
Administrative Reinsurance(SM)
Administrative Reinsurance(SM) is Life Re's other core line of business. In furtherance of Life Re's strategy of providing its clients with block reinsurance of existing insurance in force and assisting those clients who wish to discontinue the administration of older non-core blocks of business, Life Re established its Administrative Reinsurance(SM) line of business. By combining an administrative transfer with block reinsurance of insurance in force, Life Re's clients may realize value and release capital embedded in non-core businesses or ease administrative burdens and costs associated with maintaining outdated or inefficient systems. Through Administrative Reinsurance(SM), Life Re participates in the consolidation in the life insurance industry by focusing on acquiring non-core or smaller blocks of life insurance in force.
Administrative Reinsurance(SM) takes at least two forms: the reinsurance of insurance in force from life insurers, and the acquisition of life insurance companies that lack critical mass to effectively market products and efficiently administer blocks of insurance. In either case, Life Re generally organizes the conversion of the client's block of business to the systems of one of its current third party administrators, including Cybertek Corporation ("Cybertek"), Computer Sciences Corporation ("CSC") or Transaction Applications Group, Inc. ("TAG").
The Company generally utilizes the services of outside administrators to provide the administrative services needed for the primary business. The administrative services provided by the outside administrators are set forth in written agreements and include premium processing, billing, policyholder service and claims administration. The use of several outside administrators allows the Company to efficiently integrate
acquisitions and retain the capacity to pursue multiple acquisition opportunities simultaneously, while at the same time reduce its dependence on any one provider. The supervision of the outside administrators is performed by Life Re.
During 1998, the Company's completed Administrative Reinsurance(SM) transactions included the reinsurance of blocks of insurance in force with respect to business from Allianz Insurance Company of North America ("Allianz") and CNA Financial Corporation ("CNA"), and the acquisitions of Mission Life, Lincoln Liberty Life, First Delaware Life, Atlas Life, Capitol Bankers Life, Aristar Life and First Capital Life. These transactions, in the aggregate, added approximately $850 million in assets and liabilities to Life Re, consisting primarily of fixed maturities and future policy benefits, respectively.
In connection with the Allianz transaction, in December 1997, the Company entered into a transaction whereby the Company and Employers Reassurance Corporation ("ERAC") coinsured a block of life insurance and annuity business from Allianz, with the Company's portion of the business reinsured increasing from 20% to 60% during 1998. The total block of business being coinsured entails approximately $1.1 billion of life insurance and annuity reserves. Under its agreement with ERAC, the Company assumed administrative responsibility for this block. The administration of the block is performed by CSC. Effective October 1, 1998, the Company's share of the business reinsured increased to 60%.
Included in Administrative Reinsurance(SM) is the automobile credit life and disability reinsurance line of business. In connection with such business, in July 1996, Life Re entered into certain transactions with Resource Financial Corporation ("Resource"), which was formerly Ryan Dealer Group and a subsidiary of Aon Corporation ("Aon"). Resource also purchased from Aon a life insurance carrier, American Combined Life Insurance Company, which was renamed Resource Life Insurance Company ("Resource Life").
Group Accident and Health and Special Risk Reinsurance (in run-off)
Life Re announced in 1997 its withdrawal from the group accident and health and special risk reinsurance business. Accordingly, the Company did not renew or accept new participations in this line of business during 1998. The Company previously had reduced or canceled certain of its participations, and effective January 1, 1997, retroceded 50% of its 1997 group accident and health and special risk reinsurance risks. Group accident and health reinsurance consists of the reinsurance of medical expense, disability and accident risks. Special risk reinsurance consists principally of accidental death coverage and catastrophic excess of loss coverage, as well as occupational accident coverage. In the substantial majority of Life Re's group accident and health reinsurance treaties, the original client is a self insured corporate health plan. Reinsurance for such self insured plans is secured in order to minimize the risk to the plan of claims in excess of those originally projected. The reinsurance is usually in the form of specific and aggregate stop loss coverage. Specific stop loss coverages provide for reimbursement of individual losses in excess of a specified per person retention. Aggregate stop loss covers accumulations of claims within the specified retention, once they exceed an agreed percentage (usually 125%) of the total original estimated claims cost. The average specified retention is generally at a level in excess of $25,000 to $100,000 per person. Group accident and health and special risk reinsurance policy revenues were $58.9 million, $121.2 million and $139.7 million in 1998, 1997 and 1996, respectively.
Life Re generally participated in group accident and health and special risk reinsurance through reinsurance facilities. Such reinsurance facilities typically are formed by managing general underwriters to accept given types of risk. The managing general underwriters then market their facilities and invite reinsurers to share the risks. Usually, reinsurance facilities consist of several reinsurance companies. Other functions performed by managing general underwriters typically include underwriting of the reinsurance risk, adjustment and payment of claims, marketing and accounting.
Reinsurance of group accident and health and special risk business generally was written on an annual basis resulting in the terms of such contracts being subject to renegotiation or cancellation each year. Many of the specific and aggregate medical facilities have a profit commission feature which is based on the profitability of the treaty.
As measured by policy revenues, a substantial portion of the group accident and health and special risk business was written on an excess basis.
At December 31, 1998, Life Re reinsured risks under treaties with approximately 150 ceding client entities with respect to group accident and health and special risk business. In 1998, 21 ceding client entities each accounted for at least $1.0 million of group accident and health or special risk policy revenues and represented, in the aggregate, approximately 94% of Life Re's group accident and health and special risk policy revenues. Prior to withdrawing from this line of business, Life Re marketed its group accident and health and special risk reinsurance to a broad cross section of client entities, which varied in size, corporate structure and geographic location. No group accident and health or special risk ceding client entity accounted for more than 5% of Life Re's policy revenues in 1998.
On group health reinsurance, Life Re generally retains up to $300,000 for any one insured person per year. Life Re's net liability in excess of its retention up to $1.0 million is retroceded to a pool of reinsurers and the next $1.0 million of liability is retroceded to a single retrocessionaire. For one group health client, Life Re has a retrocessional arrangement with a single retrocessionaire. To date, Life Re has not experienced any default in connection with its group health retrocessional arrangements.
On special risk reinsurance, Life Re generally retains up to $1.0 million on any one risk. Amounts in excess of $1.0 million are retroceded to a syndicate of reinsurers in Europe. Life Re has not experienced any difficulty in collecting claims recoverable from its special risk retrocessionaires.
Approximately 8% of group accident and health and special risk reinsurance was written directly. The remaining 92% of group accident and health and special risk reinsurance was placed through reinsurance intermediaries, and of that amount, 21% was placed by a single intermediary, D.W. Van Dyke and Company of Connecticut, Inc. Intermediaries solicit, negotiate or place reinsurance cessions or retrocessions on behalf of a ceding insurer, reinsurer or a reinsurance facility. Intermediaries do not have the authority to bind Life Re with respect to reinsurance agreements, and Life Re does not commit in advance to accept any portion of the business that intermediaries submit.
UNDERWRITING
Life Re has developed underwriting guidelines, policies and procedures with the objective of controlling the quality and pricing of business written. Life Re's underwriting process emphasizes close collaboration among its underwriting, actuarial, administration and claims departments.
Life Re determines whether to write reinsurance business by considering many factors, including the type of risks to be covered, ceding company retention and binding authority, product and pricing assumptions and the ceding company's underwriting standards, financial strength and distribution systems. Life Re generally does not assume 100% of a risk and requires the ceding company to retain at least 10% of every reinsured risk. Life Re generally assumes all of the risks in connection with Administrative Reinsurance(SM).
Life Re regularly updates its underwriting policies, procedures and standards to take into account changing industry conditions, market developments and changes in medical technology. Life Re endeavors to ensure that the underwriting standards and procedures of its ceding client entities are compatible with those of Life Re. Toward this end, Life Re conducts periodic reviews of the ceding clients' underwriting and claims procedures. Life Re maintains its underwriting manual, which is distributed for use by its ceding clients, to reflect current medical technology and Life Re's underwriting standards. In addition, with respect to a portion of Life Re's run-off group accident and health and special risk reinsurance business, certain underwriting functions are performed on Life Re's behalf by managing general underwriters according to underwriting guidelines reviewed by Life Re.
MARKETING
Life Re has developed its business on the basis of direct marketing relationships established over many years through responsive service. Life Re's senior management is directly involved in most aspects of Life Re's marketing efforts, including the formulation, execution and evaluation of marketing strategies, the identifica-
tion of marketing opportunities and the maintenance of relationships with senior executives at client companies. Life Re seeks to evaluate each client's specific reinsurance needs, tailor reinsurance programs to meet those needs and be responsive in processing claims. Life Re believes this strategy will enable it to achieve its objective of favorably competing on the basis of service as well as price.
In January 1996, Life Re announced the creation of the Office of Life Marketing. The Office of Life Marketing is responsible for direct marketing of traditional life reinsurance products, all of which are marketed on a direct basis. The Office of Life Marketing consists of executives having expertise in various disciplines within the insurance industry. These disciplines include actuarial, legal, marketing and underwriting. The Office of Life Marketing is designed to provide excellent service to Life Re's clients by working with clients to identify and address their specific needs.
During 1998, most policy revenues with respect to traditional life reinsurance were written directly.
CLAIMS ADMINISTRATION
Life Re's claims department (i) reviews and verifies reinsurance claims, (ii) obtains information necessary to evaluate claims, (iii) determines Life Re's liability with respect to claims and (iv) arranges for timely claim payments. Claims are subjected to a thorough review process to ensure that the risk was properly ceded, the claim complies with the contract provisions and the ceding company is current in the payment of reinsurance policy premiums to Life Re. Ordinary life and group life claims generally are reported on an individual basis by the ceding entity. The ceding entity will provide the Company with proofs of loss, which the Company then reviews for compliance with treaty terms.
Ordinary life claims under policies reinsured on a facultative basis and underwritten within the five previous years and ordinary life claims under policies reinsured under automatic treaties and underwritten within the two previous years generally are reviewed by the underwriting department. The claims department also investigates claims generally for evidence of misrepresentation in the policy application and approval process. In addition to reviewing and paying claims, the claims department monitors both specific claims and overall claims handling procedures of ceding companies.
Group accident and health claims generally are reported to the Company by the ceding entity on an aggregate basis. The ceding entity will provide the Company with a listing of the claims paid by the ceding entity, which the Company then reviews for compliance with treaty terms.
Outside administrators provide claims administration for the Company's Administrative Reinsurance(SM) on a variable fee basis. The administrators review and process all claims information and provide for the payment of claims. The Company reviews and must approve prior to payment all claims received by the respective administrators which involve a death benefit in excess of certain specified levels or in which the insured died within two years of policy issuance.
POLICY BENEFIT LIABILITIES
Policy benefit liabilities comprise the majority of the Company's financial obligations. Policy benefit liabilities for other than annuities and interest sensitive life insurance products reflected in Life Re's consolidated financial statements included herein are based upon Life Re's best estimates of mortality, persistency and investment income, with appropriate provision for adverse deviation. The liabilities for policy benefits established by Life Re with respect to individual risks or classes of business may be greater or less than those established by ceding companies due to the use of different mortality and other assumptions. Policy benefit liabilities for annuities and interest sensitive life insurance products are reported at the accumulated fund balance of such contracts. Policy benefit liabilities include both mortality and morbidity claims in the process of settlement and claims that have been incurred but not yet reported. Actual experience in a particular period may be worse than assumed experience and, consequently, may adversely affect Life Re's operating results for such period. See Notes 2 and 7 of "Notes to Consolidated Financial Statements" for
certain additional information regarding reserve assumptions under generally accepted accounting principles ("GAAP").
INVESTMENTS
All investments made by Life Re are governed by the general requirements and guidelines established and approved by the Boards of Directors of Life Re and the Subsidiaries and by qualitative and quantitative limits prescribed by Connecticut, Illinois, Michigan and Texas insurance laws and regulations. Life Re's investment policy is designed to maintain a high quality portfolio, maximize current income, maintain a high degree of liquidity, and match the cash flows of the portfolio to the required cash flows of Life Re's liabilities.
At December 31, 1998, Life Re's invested assets had an aggregate fair value of $3,775.5 million, of which 91% were fixed maturities with a weighted average investment quality rating of "A." At December 31, 1998, the weighted average duration of invested assets was 6.3 years. In the event the duration of invested assets were to materially differ from the duration of liabilities and if significant rapid increases in market interest rates were to occur, Life Re could be required to sell assets at a loss. Conversely, if significant rapid decreases in market interest rates were to occur, Life Re could earn less income than it credits to policyholders under interest sensitive contracts. Such consequences could have a material adverse effect on Life Re's capital resources and financial condition. Although no assurances as to future performance can be given, Life Re has not experienced any material differences in cash flows relating to its assets and liabilities.
Life Re's investment securities are managed primarily by two professional investment advisors, Conseco Capital Management, Inc. ("CCM") and Liberty Capital Advisors, Inc. ("LCA"), each of which manages a segment of the portfolio. Certain equity and short-term investments aggregating approximately $122.6 million at fair value are managed directly by Life Re. CCM is the primary investment advisor for Life Re, managing 82% of its invested assets (approximately $3,105.6 million at fair value as of December 31, 1998). LCA acts as an investment advisor for the portion of Life Re's invested assets relating to the reinsured universal life insurance policies of an affiliate of LCA (approximately $281.0 million at fair value as of December 31, 1998). The agreements with CCM and LCA may be terminated by either party at the end of each calendar year upon sixty days' notice. The performance of CCM and LCA and the fees associated with the arrangements are reviewed periodically by the Boards of Directors of Life Re and the Subsidiaries.
The following table summarizes certain of Life Re's investment results for the years indicated:
INVESTMENT RESULTS
- --------------- (1) Fair value at end of the indicated year.
(2) The effective yield rate equals (i) net pre-tax investment income divided by (ii) the average of total adjusted invested assets (fixed maturities at amortized cost) at the end of each calendar quarter included in the indicated period.
Life Re's invested assets consist primarily of fixed maturities. The Company's fixed maturities are invested primarily in U.S. government obligations, foreign government obligations, public utilities obligations, corporate fixed maturities, and mortgage-backed securities.
Mortgage-backed securities represented approximately 13.7% of total invested assets as of December 31, 1998. Investors in these securities are compensated primarily for reinvestment risk rather than credit quality risk. Investments in mortgage-backed securities include collateralized mortgage obligations ("CMOs") and
mortgage-backed pass-through securities. Mortgage-backed securities generally are collateralized by mortgages issued by the Government National Mortgage Association ("GNMA"), the Federal National Mortgage Association ("FNMA") and the Federal Home Loan Mortgage Corporation ("FHLMC"), all of which are agencies of the U.S. government. Of these, only GNMA mortgages are backed by the full faith and credit of the U.S. government. Credit risk generally is not a consideration when investing in agency mortgage-backed securities. Life Re's mortgage-backed securities portfolio had a weighted average investment quality rating of AAA at December 31, 1998.
At December 31, 1998 approximately 25.0% of Life Re's mortgage-backed investment portfolio consisted of planned amortization class ("PAC") and target amortization class ("TAC") instruments. These investments are designed to amortize in a more predictable manner by shifting the primary risk of prepayment of the underlying collateral to investors in other tranches ("support classes") of the CMO.
In addition to fixed maturities, approximately 4.8% of the Company's invested assets consisted of policy loans at December 31, 1998. These policy loans present no credit risk because the amount of the loan cannot exceed the obligation due the ceding company upon the death of the insured or surrender of the underlying policy. The policy loan interest rates charged are determined by the provisions of the treaties in force and the underlying policies.
COMPETITION
Life Re operates in a highly competitive environment. Reinsurers compete based upon many factors, including financial strength, A.M. Best rating, pricing and other terms and conditions of reinsurance agreements, reputation, service and experience in the lines of business underwritten. Life Re believes that there are over 30 companies with significant competitive positions within the traditional life reinsurance market. Life Re believes that within this market it is among the five largest of those companies, based on reinsurance in force.
In connection with Administrative Reinsurance(SM), the nature of the competition faced by Life Re depends on the company targeted for acquisition or the block of business to be reinsured. Based on results achieved thus far, Life Re believes that it is competitively positioned to achieve its objectives for growth in this area.
A.M. BEST RATING
Life Reassurance has been rated "A+" (Superior) by A.M. Best every year since 1981. A.M. Best's ratings for insurance companies currently range from "A++" to "F", and some companies are not rated. Publications of A.M. Best indicate that "A++" and "A+" ratings are assigned to those companies which in A.M. Best's opinion have achieved superior overall performance when compared to the norms of the life insurance industry and generally have demonstrated a strong ability to meet their policyholder and other contractual obligations. Life Reassurance's A.M. Best "Financial Size Category" is Class VIII, which encompasses companies with adjusted policyholders' surplus of $100.0 million to $250.0 million.
REALIC currently is rated "A" (Excellent) by A.M. Best, the rating that was given to REALIC prior to its acquisition by Life Reassurance. Publications of A.M. Best indicate that "A" and "A-" ratings are assigned to those companies which in A.M. Best's opinion have a strong ability to meet their obligations to policyholders over a long period of time. REALIC's A.M. Best "Financial Size Category" is Class VI, which encompasses companies with adjusted policyholders' surplus of $25.0 million to $50.0 million.
In evaluating a company's financial and operating performance, A.M. Best reviews such company's profitability, leverage and liquidity as well as its book of business, the adequacy and soundness of its reinsurance, the quality and estimated market value of its assets, the adequacy of its policy reserves and the experience and competency of its management. A.M. Best's ratings are based upon factors of concern to policyholders, agents and intermediaries and are not directed toward the protection of investors.
EMPLOYEES
As of December 31, 1998, Life Re had 119 employees. None of these employees is represented by a labor union. Life Re believes that its relationship with its employees is satisfactory.
REGULATION
The Company and the Subsidiaries are subject to the insurance laws and regulations of Connecticut, Illinois, Michigan and Texas, the domiciliary states of the Subsidiaries, and the laws and regulations of the other states in which the Subsidiaries are licensed to do business. At present, Life Reassurance is licensed to conduct business or is an authorized reinsurer in all 50 states, the District of Columbia and Puerto Rico, and REALIC is licensed to conduct business in all such locations except for New Hampshire, New York, and Puerto Rico. The insurance laws and regulations, as well as the level of supervisory authority that may be exercised by the various state insurance departments vary by jurisdiction, but generally grant broad powers to supervisory agencies or state regulators to examine and supervise insurance companies and insurance holding companies with respect to every significant aspect of the conduct of the insurance business. These laws and regulations generally require insurance companies to meet certain solvency standards and asset tests, to maintain minimum standards of business conduct and to file certain reports with regulatory authorities, including information concerning their capital structure, ownership and financial condition. The Subsidiaries generally are required to file annual and quarterly statutory financial statements in each jurisdiction in which they are licensed. Additionally, the Subsidiaries are subject to periodic examination by the insurance departments of the jurisdictions in which each is licensed, authorized and accredited. The Connecticut Insurance Department completed its most recent examination of Life Reassurance for the years ended December 31, 1993 through December 31, 1996, and the Texas Department of Insurance completed its examination of TexasRe for years through December 31, 1995. The Illinois Department of Insurance completed its most recent examination of REALIC for years through December 31, 1995. The results of each of the completed examinations contained no findings which would have a material adverse effect on the operations of any of the Subsidiaries. Although the rates and policy terms of primary insurance agreements are regulated by state insurance departments, the rates, policy terms and conditions of reinsurance agreements generally are not subject to regulation by any regulatory authority.
Restrictions on Dividends and Distributions. The principal sources of cash for the Company to make payments of principal and interest are payments under two surplus notes issued by TexasRe to the Company in connection with the purchase of Life Reassurance from General Reinsurance Corporation in 1988 (the "Surplus Debentures") and dividends paid by TexasRe. TexasRe's principal sources of funds are dividends from Life Reassurance and distributions by Life Reassurance under a tax allocation agreement among the Company, TexasRe and Life Reassurance (the "Tax Allocation Agreement"), a portion of which distributions are used to pay TexasRe's income taxes. Under current Connecticut, Illinois, Michigan and Texas laws, any proposed payment of a dividend or distribution which, together with dividends or distributions paid during the preceding twelve months, exceeds the greater of (i) 10% of statutory capital and surplus as of the preceding December 31 or (ii) statutory net gain from operations for the preceding calendar year, is designated an "extraordinary dividend" and may not be paid until either it has been approved, or a 30-day waiting period shall have passed during which it has not been disapproved, by the Insurance Commissioner of the State of Connecticut (the "Connecticut Insurance Commissioner"), the Director of Insurance of the State of Illinois (the "Illinois Director of Insurance"), the Insurance Commissioner of the State of Michigan (the "Michigan Insurance Commissioner")or the Commissioner of Insurance of the State of Texas (the "Texas Insurance Commissioner"), as the case may be. In addition, Connecticut law provides that an insurance company may not pay dividends in an amount exceeding its earned surplus without prior regulatory approval. Life Reassurance has received approval from the Connecticut Department of Insurance to define its earned surplus for this purpose to include amounts of paid in surplus in excess of $125.0 million, and as of December 31, 1998, such earned surplus was $242.7 million. Currently, no prior approval of the Texas Department of Insurance is required to pay scheduled principal or interest on the Surplus Debentures provided that, after giving effect to any such payment, the statutory surplus of TexasRe exceeds $125.0 million. Life Reassurance paid no dividends in 1998 and paid $23.2 million of dividends in 1997, which was the maximum amount of
dividends Life Reassurance could have paid in 1997 without the prior approval of the Connecticut Insurance Commissioner. Life Reassurance paid $14.9 million of dividends in 1996, although the maximum amount of dividends Life Reassurance could have paid in 1996 without the prior approval of the Connecticut Insurance Commissioner was $34.8 million. TexasRe had the capacity to pay dividends of $12.6 million, $16.3 million, and $27.1 million in 1998, 1997 and 1996, respectively, without the prior approval of the Texas Insurance Commissioner. TexasRe paid no dividends in 1998 and paid dividends aggregating $16.3 million and $12.1 million in 1997 and 1996, respectively. REALIC has not paid any dividends subsequent to its acquisition by Life Reassurance in July 1995. Capitol Bankers Life paid an extraordinary dividend of $35.0 million to Life Reassurance in 1998.
The Connecticut, Illinois, Michigan and Texas insurance laws require that the statutory surplus of Life Reassurance, REALIC, Capitol Bankers and TexasRe, as the case may be, following any dividend or distribution, be reasonable in relation to its outstanding liabilities and adequate to meet its financial needs. The Insurance Commissioner of any such state may bring an action to enjoin or rescind the payment of a dividend or distribution that would cause statutory surplus to be unreasonable or inadequate under this standard.
In the event of a default on the Company's capital securities or the bankruptcy, liquidation or other reorganization of the Company, the capital securities holders of the Company will have no right to proceed against the assets of the Life Reassurance, REALIC, Capitol Bankers or TexasRe. If Life Reassurance, REALIC, Capitol Bankers or TexasRe were to be liquidated, such liquidation would be conducted by the Connecticut, Illinois, Michigan or Texas Insurance Commissioner, as the case may be, as the receiver with respect to such insurance company's property and business. Under the Connecticut, Illinois, Michigan and Texas insurance laws, all creditors of such insurance companies, including, without limitation, holders of its reinsurance agreements and the various state guaranty associations, would be entitled to payment in full from such assets before the Company, as a stockholder, would be entitled to receive any distribution therefrom.
Codification. The National Association of Insurance Commissioners (the "NAIC") is in the process of codifying statutory accounting principles. The purpose of such codification is to establish a uniform set of accounting rules and regulations for use by insurance companies in financial report preparation in connection with financial reporting to regulatory authorities. The Company is unable to determine what impact, if any, this codification will have on its Subsidiaries' statutory surplus requirements.
Assessments Against Insurers. Under insolvency or guaranty laws in most states in which the Company operates, insurers can be assessed for policyholder losses incurred by insolvent insurance companies. At present, most insolvency or guaranty laws provide for assessments based upon the amount of primary insurance, rather than reinsurance, underwritten in a given jurisdiction. Primary insurance written by REALIC is subject to such laws. REALIC incurred an immaterial amount of guaranty fund assessments in 1998. To date, the Company has paid only a de minimis amount of assessments with respect to insurer insolvency proceedings.
Insurance Holding Company Regulations. The Company and the Subsidiaries are subject to regulation under the insurance and insurance holding company statutes of Connecticut, Illinois, Michigan and Texas. The insurance holding company laws and regulations vary from jurisdiction to jurisdiction, but generally require insurance and reinsurance subsidiaries of insurance holding companies to register with the applicable state regulatory authorities and to file with those authorities certain reports describing, among other information, their capital structure, ownership, financial condition, certain intercompany transactions and general business operations. The insurance holding company statutes also require prior regulatory agency approval or, in certain circumstances, prior notice of certain material intercompany transfers of assets as well as certain transactions between insurance companies, their parent companies and affiliates.
Under the Connecticut, Illinois, Michigan and Texas insurance laws, unless (i) certain filings are made with the Connecticut Insurance Department, the Illinois Department of Insurance, the Michigan Department of Insurance or the Texas Department of Insurance, as the case may be, (ii) certain requirements are met, including, in the case of Texas, a public hearing and/or (iii) approval or exemption is granted by the applicable insurance commissioner, no person may acquire any voting security or security convertible into a voting security of an insurance holding company, such as the Company, which controls a Connecticut
insurance company or an Illinois insurance company or a Michigan insurance company or a Texas insurance company, or merge with such a holding company, if as a result of such transaction such person would "control" the insurance holding company. "Control" is presumed to exist in Connecticut, Illinois, Michigan and Texas if a person directly or indirectly owns or controls 10% or more of the voting securities of another person.
Federal Regulation. Although the federal government generally does not directly regulate the insurance or reinsurance industries, federal legislation, financial services regulation and federal taxation can significantly affect the insurance business. In recent years, increased scrutiny has been placed upon the insurance regulatory framework and legislation has been introduced in Congress which could result in the federal government assuming some role in the regulation of the insurance industry.
It is not possible to predict the future impact of changing state and federal regulation on the operations of the Subsidiaries or the Company, and there can be no assurance that existing insurance related laws and regulations will not become more restrictive in the future or that laws and regulations enacted in the future will not be more restrictive.
TAX MATTERS
Under applicable provisions of the Internal Revenue Code of 1986, as amended (the "Code"), a life insurance company is not permitted to file a consolidated federal income tax return with a company that is not a life insurance company until such life insurance company has been a member of the "affiliated group" (as such term is defined for federal income tax purposes) for five taxable years. REALIC, Mission Life, Capitol Bankers Life and AML will each file a separate company income tax return for the short taxable year ended with the date of the merger. AML has retained its small life insurance company identity and will be taxed accordingly. TexasRe and Life Reassurance (together, the "Life Tax Group") as life insurance companies, file a consolidated federal income tax return with Life Re for the short taxable year ended with the date of the Merger. Losses generated by Life Re can be used to offset taxable income of the Life Tax Group reported on the consolidated federal income tax return and those losses can only be so used to a limited extent (generally, the lesser of 35% of such losses or 35% of the taxable income of the Life Tax Group).
Pursuant to the Tax Allocation Agreement, the members of the Life Tax Group are required to pay to Life Re an amount of tax measured by the total amount that would have been due and payable by the Life Tax Group to the taxing authorities had the Life Tax Group filed a life insurance company consolidated federal income tax return. That amount is required to be paid even if Life Re is, due to its own tax status apart from the Life Tax Group, in a net tax loss or nontaxable position. In the event that the Life Tax Group incurs tax losses, credits or other benefits (including tax loss or credit carryforwards) that reduce the tax liability of the consolidated group consisting of the Life Tax Group and Life Re, Life Re is required to pay to the Life Tax Group the amount of such reduction.
ITEM 2
ITEM 2 PROPERTIES
Life Re's principal operations are conducted from approximately 51,000 square feet of leased office space located at 969 High Ridge Road, Stamford, Connecticut 06905. The lease with respect to such space expires on September 30, 2004. The rental expense paid by Life Re under the lease during 1998 was $1.0 million.
ITEM 3
ITEM 3 LEGAL PROCEEDINGS
Life Re is not a party to any material pending litigation or arbitration.
ITEM 4
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of 1998, one matter was submitted to the security holders of Life Re for a vote. The meeting was held on November 23, 1998 and it was a Special Meeting of Stockholders. The matter that was voted upon at the meeting concerned the approval of the Agreement and Plan of Merger, dated as of July 27, 1998, by and among Swiss Reinsurance Company, a Swiss corporation, SRC Acquisition Corp., a
Delaware corporation and a wholly owned subsidiary of Swiss Re, Swiss Re America Holding Corporation, a Delaware corporation and a wholly owned subsidiary of Swiss Re and the Company. Votes were cast as follows:
PART II
ITEM 5
ITEM 5 MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION
The common stock of Life Re was listed for trading on the New York Stock Exchange (the "NYSE") under the symbol LRE from October 28, 1992, the date of Life Re's initial public offering, until December 1, 1998, the date of the Merger. Based upon information reported in the Bloomberg consolidated transaction reporting system, the high and low sales prices for each quarterly period from January 1, 1997 to December 1, 1998 were:
As of March 30, 1999, there is one holder of the outstanding shares of common stock, Swiss Re America Holding Inc.
DIVIDENDS
Dividends of $0.13 per share were declared in each calendar quarter of 1997 and dividends of $0.15 per share were declared in the first three calendar quarters of 1998.
ITEM 6
ITEM 6 SELECTED FINANCIAL DATA
The following table sets forth selected financial data and other operating information. The selected financial data have been derived from the consolidated financial statements of Life Re Corporation and Subsidiaries ("Life Re") and should be read in conjunction with the consolidated financial statements and accompanying notes of Life Re and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere herein.
- --------------- (1) Capital invested in Administrative Reinsurance transactions represents the sum of the consideration paid for life insurance in force acquired and the related capital to support the business.
(2) Amounts have been derived from the Annual Statements of Life Reassurance, REALIC, Mission Life, Capitol Bankers Life, AML and TexasRe, as filed with insurance regulatory authorities and prepared in accordance with statutory accounting practices. For purposes of this presentation, capital and surplus are defined as statutory capital and surplus of Life Reassurance only, as its capital and surplus materially reflect that of Life Reassurance, REALIC and TexasRe, plus the Asset Valuation Reserve ("AVR") and the Interest Maintenance Reserve ("IMR") of Life Reassurance and REALIC.
ITEM 7
ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following analysis of Life Re's consolidated financial condition and results of operations should be read in conjunction with "Selected Financial Data" and the consolidated financial statements and accompanying notes included elsewhere herein.
With the exception of historical information, the matters contained in the following analysis are "forward looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended. Such statements may include, but are not limited to, projections of earnings, revenues, income or loss, capital expenditures, plans for future operations and financing needs or plans, as well as assumptions relating to the foregoing. The words "expect", "project", "estimate", "predict", "anticipate", "believes" and similar expressions are also intended to identify forward-looking statements. Forward-looking statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified. Future events and actual results, performance and achievements could differ materially from those set forth in, contemplated by or underlying the forward-looking statements. Such factors include, but are not limited to, the uncertainties relating to general economic and business conditions which may impact the reinsurance marketplace; changes in laws and government regulations applicable to Life Re, the ability of Life Re to implement its operating strategies successfully, the ability of Life Re to execute Administrative Reinsurance transactions and the amount, timing and returns therefrom; material fluctuations in interest rate levels; material changes in mortality and morbidity experience; material changes in persistency; material changes in the level of operating expenses; and the success or failure of certain of Life Re's clients in premium writing, and other risks and uncertainties. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual outcomes may vary materially from those indicated.
General
The preparation of financial statements in conformity with generally accepted accounting principles requires the use of estimates and assumptions developed by management. Any adjustments to reported bases of assets or liabilities resulting from changes in estimates are reflected in earnings in the period the estimates are revised. Certain management estimates are based, in part, on information provided by ceding companies. As is usual in the reinsurance business, Life Re's ceding companies periodically update, refine and revise reinsurance information provided to Life Re. The financial effects resulting from the incorporation of revised data are reflected in earnings as changes in estimates.
Mortality and morbidity experience, both significant factors in the determination of the results of operations of Life Re, generally are predictable over time but are subject to fluctuations from year to year and quarter to quarter. Significant fluctuations from period to period could adversely affect Life Re's results of operations.
Life Re's reinsurance agreements frequently provide for rights of recapture, which permit the ceding company to increase the amount of liability it retains on the reinsured policies after the policies have remained in force for a designated period of time (generally ten to twenty years). Accordingly, an increase in the amount of liability retained by the ceding company will decrease both Life Re's insurance in force and premiums to be received from the reinsured policies. To date, recaptures have not had a material impact on Life Re's results of operations.
Life Re retrocedes portions of certain risks in excess of a predetermined retention amount for which it has accepted liability. From time to time, Life Re also has entered into quota share retrocessional agreements, and maintained catastrophe reinsurance to protect against catastrophic event risks. Failure of a retrocessionaire to honor its obligations could result in material losses to Life Re; to date, no such losses have occurred. No amounts due Life Re from its retrocessionaires were deemed uncollectible at December 31, 1998.
In 1998, Life Re derived approximately 68% of its policy revenues from traditional life reinsurance, which includes ordinary and group life reinsurance. Ordinary life reinsurance policy revenues were derived under agreements with approximately 500 ceding companies and accounted for approximately 65% of total policy
revenues. The agreements cover primarily new business to be written by the client and/or existing blocks of in force business. This business is predominately marketed directly by Life Re without the use of intermediaries. In 1998, 64 ceding companies each accounted for at least $1.0 million of ordinary life reinsurance policy revenues and in the aggregate represented approximately 95% of Life Re's ordinary life reinsurance policy revenues.
Group life reinsurance accounted for approximately 3% of policy revenues in 1998. Group life reinsurance is written on a direct basis and generally is excess of loss and often includes experience rating provisions.
Approximately 24% of 1998 policy revenues were derived from Administrative Reinsurance. This line of business involves the acquisition and administration of blocks of primary insurance policies (both interest sensitive and traditional) and annuity contracts and is expected to become an increasingly significant component of policy revenues in the future. This line of business also includes Life Re's reinsurance of automobile credit life and disability.
Approximately 8% of Life Re's policy revenues were generated from group accident and health and special risk reinsurance in 1998. This business generally is written on an annual basis through reinsurance facilities which are managed by managing general underwriters. Generally the risks are shared by several reinsurers on a quota share basis. During 1997, Life Re withdrew from the group accident and health and special risk marketplace. Life Re previously had reduced or canceled certain pool participations, and effective January 1, 1997, retroceded 50% of its 1997 group accident and health and special risk reinsurance risks. For the year ended December 31, 1998, Life Re had $58.9 million of policy revenues related to group accident and health and special risk reinsurance, a reduction of 51% from the prior year. Life Re anticipates further declines of 80% in 1999 and policy revenues are expected to be minimal beyond 2000. Life Re expects no adverse financial impact from its withdrawal from this business.
Recent Transactions
On December 1, 1998, Swiss Reinsurance Company ("Swiss Re") acquired in a merger transaction (the "Merger") all of the outstanding common shares of Life Re Corporation for $95.00 per share. Additionally, consideration equal to $95.00 less the exercise price was paid in exchange for the cancellation of all outstanding common stock options. The total cash purchase price was $1,801.2 million. Pursuant to the Merger, Life Re became a wholly owned indirect subsidiary of Swiss Re. Concurrently with the Merger, Life Re received a capital contribution of $207.6 million from Swiss Re and repaid all outstanding bank loans.
In 1995, Life Re, through its acquisition of REALIC, put into place a platform for acquiring and administering blocks of primary insurance in force. This platform, known as Administrative Reinsurance, provides a mechanism for an insurer to transfer to Life Re administrative responsibilities to facilitate the insurer's exit from a line of business by means of reinsurance or sale. Life Re outsources policy administration to third party administrators while maintaining management responsibilities.
During 1998 and 1997, Life Re completed several transactions through which it acquired blocks of insurance in force (collectively, the "Transactions"). The 1998 transactions were the acquisition of 100% of the common stock of Capitol Bankers Life Insurance Company, Mission Life Insurance Company, Lincoln Liberty Life Insurance Company, First Delaware Life Insurance Company, Atlas Life Insurance Company, Aristar Life Insurance Company and First Capital Life Insurance Company of Louisiana. In 1998, Life Re also entered into several indemnity reinsurance agreements and recaptured the 40% retroceded portion of a block of business assumed in 1997 in conjunction with Employers Reassurance Corporation from Allianz Life Insurance Company of North America ("Allianz"). The 1998 transactions represented assets acquired of approximately $850.0 million. The 1997 transactions, which were the 79% stock purchase of AML Acquisition Company, parent of American Merchants Life Insurance Company, a coinsurance agreement with UNUM Life Insurance Company of America and the coinsurance agreement with Employers Reassurance Corporation covering in force business of Allianz, together represented assets acquired of approximately $970.0 million. The assets received as a result of the Transactions consisted primarily of cash and high quality investments. The Transactions were accounted for under the purchase method of accounting, and therefore, results of operations include the effect of the Transactions only from their respective dates of acquisition. For
1998 and 1997, the Transactions contributed policy revenues totaling $94.0 million and $26.0 million, respectively, and approximately $65.3 million and $32.7 million, respectively, of investment income. Policy revenues and investment income related to the Transactions exclude the effects of the acquisition of REALIC and the reinsurance of automobile credit life and disability.
Results of Operations
NET INCOME decreased by $81.9 million in 1998 to a loss of $32.4 million, compared with $49.5 million of income in 1997; in 1996, net income was $54.2 million. Included in the 1998 results were pretax costs related to the Merger of $107.4 million. Income taxes in excess of the statutory rate in 1998 resulted from the non-deductibility of certain of these costs. After-tax realized investment gains of $2.0 million and $2.9 million in 1998 and 1997, respectively, were also included in these results. In March 1996, Life Re realized a gain of $13.5 million from the sale of its equity investment in Nacolah Holding Corporation, parent of North American Company for Life and Health Insurance (see Note 6 of "Notes to Consolidated Financial Statements"). Life Re utilized existing tax net operating loss carryforwards to offset the taxes otherwise payable in connection with the gain and reversed an existing deferred tax valuation allowance, resulting in a tax benefit of $4.8 million.
EARNINGS EXCLUDING REALIZED INVESTMENT GAINS AND AFTER-TAX MERGER COSTS increased by $15.5 million, or 33%, to $62.1 million in 1998 compared with $46.6 million in 1997 and $38.3 million in 1996. The increase in earnings experienced in 1998 and 1997 was due to higher volumes of ordinary life reinsurance in force and the Transactions, partially offset by a deterioration in accident and health morbidity experience.
POLICY REVENUES by segment for the three year period are as follows:
The growth in ordinary life reinsurance revenues largely was due to new reinsurance agreements entered into during the last three years. First year premiums totaled $77.8 million in 1998 and increased by 72% and 53% in 1998 and 1997, respectively. The ordinary life reinsurance in force lapse rate has ranged from 9-11% during the last three years.
The growth in Administrative Reinsurance policy revenues was due to the Transactions and an increase in automobile credit reinsurance premiums.
Group accident and health and special risk premiums decreased by $62.3 million in 1998 due to Life Re's aforementioned reduced participations and retrocession agreement. Due to Life Re's decision to exit the accident and health and special risk reinsurance business, it anticipates further declines in group accident and health and special risk premiums of 80% in 1999. Premiums are expected to be minimal beyond 2000. Growth in 1996 was due principally to increased participation in major medical and accident reinsurance pools and quota share arrangements.
INVESTMENT INCOME increased by 55% in 1998 to $233.9 million and by 21% in 1997 to $151.0 million. These increases largely were due to the growth in invested assets resulting from the Transactions and the proceeds received from the issuance of common stock and Adjustable Conversion-rate Equity Security Units (see Financial Condition and Liquidity section). This rate of growth is dependent on new Administrative Reinsurance transactions and, to a lesser extent, new ordinary life reinsurance business. The weighted average portfolio yield rate (amortized cost basis) was 7.1% in 1998, 7.4% in 1997 and 7.8% in 1996. The decrease in the yield rate primarily is due to the investment of assets acquired from the Transactions at current rates.
POLICY BENEFITS increased by 50% in 1998 and 3% in 1997. The increase in 1998 was due to the Transactions and higher volumes of ordinary life reinsurance business. The increase in 1997 was due to an increase in accident and health and special risk pool participations, the 1996 Transactions and the purchase of REALIC in July 1995. As a percentage of policy revenues, policy benefits were 72% in 1998 and 70% in 1997 and 74% in 1996. The increase in 1998 is largely attributable to higher morbidity in the group accident and health and special risk reinsurance lines of business. Contributing to the lower percentage in 1997 was a shift in the mix of ordinary life reinsurance business from excess to first dollar quota share reinsurance; under first dollar quota share reinsurance, typically a higher portion of the reinsurance premium funds acquisition costs and a lesser portion funds mortality costs. Partially offsetting the shift in the mix of ordinary reinsurance business in 1997 was a deterioration in group accident and health and special risk morbidity experience. The higher percentage in 1996 primarily was due to an increase in revenues generated under reinsurance treaties with no acquisition costs, coinsurance involving paid-up insurance and Administrative Reinsurance, which generally produces no new business and, therefore, generally has a higher ratio of benefits to policy revenues.
ACQUISITION COSTS increased by 33% in 1998 and 27% in 1997. The increase in 1998 largely is due to the higher volumes of ordinary life business and the Transactions. The increase in 1997 reflects the higher volumes of ordinary life and group accident and health reinsurance business and the Transactions and, in addition, the aforementioned shift in the mix of ordinary reinsurance business from excess reinsurance to first dollar quota share reinsurance. As a percentage of policy revenues, policy acquisition costs were 27% in 1998, 29% in 1997 and 25% in 1996.
INTEREST CREDITED TO POLICYHOLDER ACCOUNTS increased by 86% in 1998 and by 17% in 1997. These increases are attributable to Transactions as the majority of the policy benefit liabilities acquired in these transactions are interest sensitive.
INTEREST EXPENSE decreased to $7.4 million in 1998 from $8.0 million in 1997 and $8.4 million in 1996. In 1998, interest expense decreased due to the repayment of bank loans on December 1, 1998. This decrease in 1997 was due to (i) a decrease in the weighted average variable rate charged on outstanding debt, which decreased to 6.0% in 1997 from 6.2% in 1996 and (ii) a decrease in the outstanding principal balance to $125.0 million resulting from a first quarter 1996 repayment of $15.0 million.
DISTRIBUTIONS ON CAPITAL SECURITIES of $15.2 million were incurred from the issuance in June 1997 of $100.0 million of 8.72% capital securities by a subsidiary trust and the issuance of 2,070,000 6.0% Adjustable Conversion-rate Equity Security Units in March 1998 by a subsidiary trust as further described in the Financial Condition and Liquidity section (also see Note 9 of the "Notes to Consolidated Financial Statements").
OTHER OPERATING EXPENSES increased in 1998 and 1997 mainly due to i) administrative fees of third party administrators ("TPAs") incurred within Administrative Reinsurance due to the Transactions and ii) higher compensation costs. Administrative Reinsurance utilizes the services of TPAs to administer all of its business; accordingly, to the extent Life Re is successful in expanding Administrative Reinsurance, its operating expenses will continue to increase.
MERGER COSTS of $107.4 million related primarily to severance and other compensation triggered by the Merger.
The effective FEDERAL INCOME TAX rate was in excess of the statutory rate primarily due to the non-deductibility of certain compensation payments triggered by the sale of the Life Re.
FINANCIAL CONDITION AND LIQUIDITY
Investments
Invested assets at fair value amounted to $3,775.5 million and $2,784.6 million at December 31, 1998 and 1997, respectively. The increase in invested assets in 1998 resulted from the Transactions and the issuance of common stock and Adjustable Conversion-rate Equity Security Units in March 1998. Net unrealized gains on
invested assets totaled $102.9 million and $101.5 million at year end 1998 and 1997, respectively, and generally reflect the lower interest rate environment.
Life Re's investment policy is designed to maintain a high quality portfolio, maximize current income, maintain a high degree of liquidity and match the cash flows of the portfolio to the required cash flows of Life Re's liabilities.
Life Re does not engage in trading activities to generate realized investment gains and, thus, does not have a trading portfolio. However, Life Re evaluates the desirability of continuing to hold a security when market conditions, creditworthiness or other measurement factors change. These changes may relate to a change in the credit risk of an issuer and a decision to sell may be made to avoid further declines in realizable value. Securities also may be sold prior to maturity to provide liquidity should the need arise.
Life Re's fixed maturity securities, which constituted 91%, or $3,417.7 million, of the total fair value of its invested assets as of December 31 1998, are predominantly investment grade, liquid securities with varying maturity dates. The fair value of such investments may vary depending on economic and market conditions, the level of interest rates and the perceived creditworthiness of the issuer.
At December 31, 1998, approximately $95.1 million (at fair value), or less than 3%, of Life Re's invested assets consisted of below investment grade securities. Life Re generally limits its investments in fixed maturities that are rated below investment grade, as these investments are subject to a higher degree of credit risk than investment grade securities. Life Re closely monitors its below investment grade securities as well as the creditworthiness of the portfolio as a whole. When fair values decline for reasons other than changes in interest rates or other perceived temporary conditions, the security is written down to its net realizable value. In 1998, 1997 and 1996, Life Re wrote down the value of certain securities by $5.9 million, $2.6 million and $0.5 million, respectively. Life Re had no fixed maturities in default at December 31, 1998.
The results of operations and the financial condition of Life Re are significantly affected by the performance of its investments and by changes in interest rates. During a period of declining interest rates, if Life Re's investments are prematurely sold, called, prepaid or redeemed, Life Re would be unable to reinvest the proceeds in securities with comparable rates of return. During a period of rising interest rates, the fair value of Life Re's invested assets could decline. In addition, rising interest rates could also cause disintermediation which in turn could cause Life Re to be required to sell investments at prices and times when the fair values of such investments are less than their amortized cost. Life Re believes that its traditional life insurance liabilities are not highly interest sensitive and, therefore, the effects of fluctuating interest rates on these liability cash flows are not significant. For interest sensitive liabilities, Life Re utilizes asset/liability matching to minimize the impact of changes in interest rates. Life Re has not engaged in hedging activities to mitigate the effects of interest rate changes on its invested assets and related liabilities.
At December 31, 1998, collateralized mortgage obligations and mortgage-backed pass-through securities represented approximately 14% of Life Re's invested assets. Certain of such investments may be subject to prepayment risk and, therefore, are susceptible to fluctuations in the level of interest rates. Prepayments of these investments did not have a material impact on Life Re's 1998 results of operations.
During 1998, 1997 and 1996, proceeds from sales of fixed maturities amounted to $799.7 million, $301.0 million and $253.4 million, respectively. The net gains realized from such sales were $7.4 million, $7.3 million and $1.8 million for the respective periods. The majority of the 1998 and 1997 sales was attributable to the restructuring of portfolios acquired in connection with the Transactions.
Real estate and mortgages (at cost) totaled $30.7 million at December 31, 1998 and were acquired as part of the Transactions. Mortgage loans comprise the majority of this amount.
Policy Benefit Liabilities
Life Re's obligations for policy benefit liabilities increased by 30% and 45% during 1998 and 1997, respectively. These increases resulted from the Transactions and increased reinsurance of new and in force life insurance. Policy benefits consist of the present value of future benefits under traditional ordinary and group
life insurance policies, account values under interest sensitive life and annuity contracts, group accident and health claim reserves, life claims payable and other miscellaneous liabilities. Through the Transactions, the relative proportion of interest sensitive and annuity policy benefit liabilities to the total has increased significantly and, at December 31, 1998, totaled approximately 60% of the policy benefits under life insurance contracts.
Asset/liability management techniques are utilized by Life Re to minimize the risks associated with interest rate fluctuations. For interest sensitive policy benefits, Life Re seeks to invest in assets with equal durations while attaining a targeted rate of return. Life Re currently does not engage in hedging transactions to mitigate the effects of interest rate fluctuations.
Debt, Capital Securities and Shareholder's Equity
On December 1, 1998, as part of the acquisition of the Company by Swiss Re, the bank loans of $125.0 million were repaid.
On June 6, 1997, Life Re completed a private placement under Rule 144A of the Securities Act of 1933, as amended, of $100.0 million of 8.72% capital securities of Life Re Capital Trust I ("Trust I"), a subsidiary of Life Re. Distributions are cumulative and payable in arrears beginning December 15, 1997. The securities have a maturity date of June 15, 2027 and may be redeemed at any time on or after June 12, 2007. Payments on the securities are fully and unconditionally guaranteed by Life Re. The securities have an effective interest rate of 8.75%. The assets of the Trust I consist of junior subordinated debentures issued by Life Re which have terms that parallel the terms of the capital securities.
On March 17, 1998 Life Re completed two separate public offerings in which it sold 3,500,000 shares of common stock, and 2,070,000 6.0% Adjustable Conversion-rate Equity Security Units issued through Life Re Capital Trust II ("Trust II") (the "Units"), (together, the "Offerings"). Life Re realized net proceeds of approximately $352 million from the Offerings. The Units consist of a stock purchase contract (the "Contract") and Quarterly Income Preferred Securities ("QUIPS"). Distributions on the QUIPS are cumulative, accrue from the first date of issuance of the QUIPS and are payable at a stipulated annual rate on a quarterly basis in arrears on a predetermined payment date. The QUIPS have a maturity of March 15, 2003 and are subject to a put option exercisable by the QUIPS holder on either March 15, 2001 or June 15, 2001. As a result of the Merger, the aggregate payment to Unit holders (net of the amount paid by Unit holders to the Company under the Contracts) will be approximately $24.6 million.
Shareholder's equity increased by $442.3 million to $816.1 million at December 31, 1998 from $373.8 million at December 31, 1997 primarily as a result of the issuance of common stock for $219.1 million, a capital contribution of $207.6 million and a tax benefit $56.4 million, partially offset by a net loss of $32.4 million, common shareholder dividends of $7.2 million, issuance costs of Trust II securities of $3.4 million and an unrealized loss of $1.3 million.
Dividends paid to common shareholders were $.45 per share in 1998, $.52 per share in 1997 and $.40 per share in 1996.
Liquidity
Sources of liquidity are available to Life Re in the form of cash and short-term investments and, if necessary, the sale of invested assets. Life Re may enter into reverse repurchase agreements to fund short-term cash needs. Additionally, Life Re believes that it has a significant source of capital and liquidity from its ultimate parent, Swiss Reinsurance Company. In addition to its capital securities distribution obligations, Life Re's financial obligations consist of policy benefit and acquisition costs, taxes and general operating expenses. During the next twelve months, management believes these obligations will be adequately provided for by policy revenues and investment income.
The primary sources of funds for Life Re Corporation (the "Parent") consist of dividends and surplus debenture interest payments from TexasRe, which are further funded by dividends from LRCA to TexasRe. The ability of the Parent to make distributions on capital securities is ultimately dependent on the statutory
earnings and surplus of its subsidiaries. The following table shows surplus debenture interest payments and dividends received by the Parent for the last three years as well as dividends available for payment in that year without prior approval of state regulatory authorities, and dividends paid to TexasRe for the last three years as well as dividends available for payment to TexasRe in that year without prior approval of state regulatory authorities:
The unpaid principal amount of the surplus debentures at December 31, 1998 was $160.5 million. The interest rate payable under the terms of the surplus debentures is 5.42%.
Currently, no prior approval of the Texas Insurance Commissioner is required to prepay or pay scheduled interest or principal on the surplus debentures provided that, after giving effect to any such payment, the statutory surplus of TexasRe is $125.0 million. TexasRe relies primarily on dividends from LRCA to meet its obligations under the surplus debentures as well as to pay dividends to Life Re Corporation.
The payments of dividends by TexasRe and LRCA are subject to restrictions set forth in Texas and Connecticut insurance laws and regulations (see Note 10 of "Notes to Consolidated Financial Statements"). Under Connecticut law, no dividend in an amount exceeding LRCA's earned surplus may be paid without prior regulatory approval. Approval has been received from the Connecticut Department of Insurance to define earned surplus for this purpose to include amounts of paid in surplus in excess of $125.0 million.
Purchases and sales of fixed maturities increased substantially in 1998 and 1997 due primarily to restructuring of portfolios related to the Transactions. The completion of these types of transactions generally produces a cash outlay for acquisitions and a net cash inflow upon reinsurance of insurance in force. Financing cash flows include debt prepayments of $15.0 million in 1996. Withdrawals from annuity and interest sensitive life insurance contracts totaled $174.4 million in 1998 compared to $108.6 million in 1997 due to increased volumes of business resulting from the Transactions and an increase in the related rate of lapsation.
IMPACT OF YEAR 2000
Life Re has completed its comprehensive review of its computer systems which could be affected by year 2000 processing issues. All of Life Re's core, or mission-critical, systems were year 2000 compliant at December 1998. Other non-core systems are planned to be compliant by June 1999. The costs associated with these efforts is not expected to exceed $1.0 million.
The computer systems of Life Re's third party administrators are or are in the process of becoming year 2000 compliant. Life Re is in the process of reviewing the third party administrators systems to ensure such compliance. Generally, the costs associated with these efforts are being borne by the third party administrators and the costs associated with this review are anticipated to be immaterial.
Life Re has sent questionnaires to its ceding company clients to determine the extent to which data received and utilized by Life Re is vulnerable to those third parties failure to remediate their own year 2000 issues. Life Re has received responses from a significant number of these clients and is in the process of evaluating the information. There is no guarantee that the systems of other companies on which Life Re may rely for data will be timely converted and would not have an adverse effect on analyses and reports that utilize
that data. However, Life Re believes its own systems and processes mitigate the risk that ceding companies year 2000 noncompliance would have a material adverse effect on its operations.
Life Re currently has no formal contingency plans in place in the event it does not complete all phases of Year 2000 compliance due to its expectation of completing all phases. However, should Life Re not complete all associated compliance work, Life Re would use estimating techniques based on available historical data to bill reinsurance premiums and record policy benefits and acquisition costs on business affected by this noncompliance. However, there can be no assurance that noncompliance would not have a material adverse impact on Life Re's operations.
ITEM 7A
ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk relates, broadly, to changes in the value of financial instruments that arise from adverse movements in interest rates, equity prices and foreign exchange rates. Life Re is exposed principally to changes in interest rates that offset the market prices of its fixed maturities. Life Re's exposure to changes in equity prices and foreign currency exchange rates is immaterial.
Interest Rate Risk
Life Re could experience economic losses if it were required to liquidate fixed income securities during periods of rising and/or volatile interest rates. However, Life Re attempts to mitigate its exposure to adverse interest rate movements through a combination of active portfolio management, asset/liability duration matching exercises, and by staggering the maturities of its fixed income investments to assure sufficient liquidity to meet its obligations and to address reinvestment risk considerations.
Asset/liability management techniques are utilized by Life Re to minimize the risks associated with interest rate fluctuations. For interest sensitive contracts, Life Re seeks to invest in assets with equal durations while attaining a targeted rate of return. Life Re currently does not engage in hedging transactions to mitigate the effects of interest rate fluctuations.
Sensitivity Analysis
Life Re regularly conducts various analyses to gauge the financial impact of changes in interest rates on its financial condition. The ranges selected in these analyses reflect management's assessment as being reasonably possible over the succeeding twelve month period. The magnitude of changes modeled in the accompanying analyses should, in no manner, be construed as a prediction of future economic events, but rather, be treated as a simple illustration of the potential impact of such events on Life Re's consolidated financial results.
The sensitivity analysis of interest rate risk assumes an instantaneous shift in market interest rates in a parallel fashion across the yield curve, with scenarios of interest rates increasing and decreasing 100 and 200 basis points from their levels at December 31, 1998, and with all other variables held constant. A 100 and 200 basis point increase in market interest rates would result in a pre-tax decrease in the market value of Life Re's fixed maturity securities of $89.1 million and $284.6 million, respectively. Similarly, a 100 and 200 basis point decrease in market interest rates would result in a pre-tax increase in the market value of Life Re's fixed maturity securities of $338.9 million and $589.4 million.
The following table reflects the estimated effects on the market value of Life Re's fixed maturity securities due to an increase in interest rates of 100 basis points. All of Life Re's fixed maturity securities have been categorized as other than trading (available for sale) in accordance with Statement of Financial Accounting Standard No. 115.
ITEM 8
ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE LIFE RE CORPORATION AND SUBSIDIARIES
REPORT OF MANAGEMENT
The Management of Life Re Corporation has primary responsibility for preparing the accompanying financial statements and for their integrity and objectivity. The statements were prepared in accordance with generally accepted accounting principles applied on a consistent basis and are fairly stated in all material respects. The financial statements include amounts that are based on management's best estimates and judgements. Management also prepared the other information presented in the annual report and is responsible for its accuracy and consistency with the financial statements.
Management of the Company has established and maintains a system of internal control that provides reasonable assurance as to the integrity and reliability of the financial statements, the protection of assets from unauthorized use or disposition and the prevention and detection of fraudulent financial reporting. In addition, the adequacy and effectiveness of the system of internal control is reviewed periodically by the Company's internal auditors.
The Company's financial statements have been audited by independent auditors. The independent auditors have unrestricted access to each member of management in conducting their audit. Management has made available to the independent auditors all of the Company's financial records and related data, as well as the minutes of shareholders' and directors' meetings. Furthermore, management believes that all representations made to the independent auditors during their audits were valid and appropriate.
The Audit Committee of the Board of Directors is comprised of certain directors who are neither employees nor officers of the Company. The Audit Committee meets periodically with management and the independent auditors regarding independent audit scope, timing, results and to discuss other auditing and financial reporting matters. The independent auditors have direct access to and meet privately with the Audit Committee.
JACQUES E. DUBOIS Chairman and Chief Executive Officer
ALAN D. HEAD Vice President and Chief Financial Officer
REPORT OF INDEPENDENT AUDITORS
The Board of Directors Life Re Corporation
We have audited the accompanying consolidated balance sheets of Life Re Corporation and subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of operations and comprehensive income, changes in shareholder's equity, and cash flows for each of the three years in the period ended December 31, 1998. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Life Re Corporation and subsidiaries at December 31, 1998 and 1997, and the consolidated 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. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
ERNST & YOUNG LLP
Stamford, Connecticut March 1, 1999
LIFE RE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral component of the consolidated financial statements.
LIFE RE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
The accompanying notes are an integral component of the consolidated financial statements.
LIFE RE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDER'S EQUITY
The accompanying notes are an integral component of the consolidated financial statements.
LIFE RE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral component of the consolidated financial statements.
LIFE RE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998
1. BASIS OF PRESENTATION AND NATURE OF BUSINESS
The accompanying consolidated financial statements of Life Re Corporation and Subsidiaries (the "Company") have been prepared in accordance with generally accepted accounting principles. All significant intercompany balances and transactions have been eliminated. All dollar amounts are reported in thousands unless otherwise indicated.
On December 1, 1998, the Company was acquired by Swiss Reinsurance Company ("Swiss Re") in a merger transaction (the "Merger") (Note 3). As is permitted in certain circumstances, the cost of the Merger was not "pushed down" to establish a new accounting basis for the Company. Accordingly, the accompanying financial statements reflect the Company's historical cost basis.
Business
The Company's business, which is conducted through its principal wholly owned life insurance subsidiaries, Life Reassurance Corporation of America ("LRCA") and Reassure America Life Insurance Company ("REALIC") and its 79% owned subsidiary, American Merchants Life Insurance Company ("AML"), consists of three segments: traditional life reinsurance, Administrative Reinsurance(SM) and group accident and health and special risk reinsurance. Traditional life reinsurance primarily involves the transfer to the Company of mortality risks on insurance products from primary (or ceding) insurers of ordinary and group life policies. Substantially all of the traditional life reinsurance business is marketed directly by the Company without the use of intermediaries. Administrative Reinsurance involves the acquisition of blocks of life insurance and/or annuity contracts in force. The Company obtains its Administrative Reinsurance business through purchases of life insurance companies and also through indemnity coinsurance and assumption reinsurance agreements with ceding insurers. The Company also assumes responsibility for policy administration of the business obtained from these transactions which it outsources to third party administrators.
Group accident and health and special risk reinsurance, involving the reinsurance of medical expenses, disability income, accidental death and catastrophic loss coverage, is conducted primarily through participation in reinsurance pools. In 1997, the Company decided to withdraw from the group accident and health and special risk reinsurance business and, since October 1997, has ceased to renew or accept new pool participations and has also ceased direct marketing activity.
Estimates, Risks and Uncertainties
The preparation of financial statements in conformity with generally accepted accounting principles requires the use of estimates and assumptions developed by management. Any adjustments to reported bases of assets or liabilities resulting from changes in estimates are reflected in earnings in the period the estimates are revised.
Certain management estimates are based, in part, on information provided by ceding companies. As is usual in the reinsurance business, ceding companies periodically update, refine and revise reinsurance information provided to the Company. The financial effects resulting from the incorporation of revised data are reflected in earnings as changes in estimates.
Mortality and morbidity experience, significant factors in the determination of the results of operations for the life insurance industry, generally are predictable over time but are subject to fluctuations from year to year and quarter to quarter. A significant fluctuation from period to period could adversely affect the Company's results of operations.
2. SIGNIFICANT ACCOUNTING POLICIES
Investments
Fixed maturities in these notes include fixed maturity securities which are part of assets held by ceding company under reinsurance treaty and those included in the caption fixed maturities in the accompanying consolidated balance sheets.
Fixed maturities, consisting of bonds and redeemable preferred stocks, and equity securities, consisting of common and nonredeemable preferred stocks, are classified as available for sale and are reported at fair value. Unrealized gains and losses on available for sale securities are recorded as other comprehensive income. These amounts are net of deferred income taxes and a valuation adjustment which represents the change in amortization of deferred acquisition costs that would have been recorded as a charge or credit to operations had the relating unrealized gains or losses been realized.
Mortgage loans are carried at amortized unpaid balances, net of provisions for estimated losses. Real estate is carried at cost.
Short-term investments are stated at cost and policy loans are stated at aggregate unpaid principal balances.
Realized gains or losses from sales of investments, determined on the specific identification basis, and declines in fair value determined to be other than temporary are included in net income.
Realized investment gains and losses are reported net of related expenses and include the amount of amortization of deferred acquisition costs resulting from the inclusion of such realized gains or losses in the gross profits used for the calculation of such amortization.
Fair Values of Financial Instruments
The fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties. All financial instruments of the Company are carried at amounts which approximate fair value except amounts related to insurance contracts, which are exempt from fair value reporting and disclosure requirements.
The following methods and assumptions were used by the Company to estimate the fair value of financial instruments reported or disclosed in the financial statements.
Investment securities: Fair values of fixed maturities and equity securities are obtained from independent pricing services which generally use quoted market prices, where available. For securities for which quoted market prices are not available and for securities which independent pricing services are unable to price, fair values are obtained from the Company's outside portfolio managers, who obtain them from broker/dealers or estimate them using analytic pricing methods. These pricing methods determine fair values by discounting expected future cash flows using current market rates applicable to the yield, credit quality and maturity of comparable quoted securities. The fair values resulting from the application of these methods are affected by the assumptions used, including the discount rate and estimates of future cash flows. Such derived fair value estimates may not be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlements of the instruments.
Policy loans: The carrying value of policy loans approximates fair value, as the average loan interest rate approximates interest rates currently offered for similar loans.
Cash and short-term investments: The carrying amounts reported for these instruments approximate their fair values, due to their short maturity.
Loans payable: The carrying value of loans payable approximates their fair value, as these loans have variable rate interest terms.
Capital Securities: The carrying value of capital securities approximates their fair value.
Insurance contracts: Fair values of insurance contracts are not required to be disclosed. The fair values of liabilities under all insurance contracts are taken into consideration in the Company's overall management of interest rate risk, which minimizes exposure to changing interest rates by seeking to match investment cash flows with amounts due under insurance contracts.
Recognition of Policy Revenues and Related Expenses
Policy revenues consist of premiums under traditional life and accident and health and special risk insurance policies and fees and charges under interest sensitive life insurance policies and annuity contracts.
Premiums are recognized as revenues over the premium paying periods of the policies. Benefits and expenses are provided against such revenues to recognize profits over the estimated lives of the policies through the provision for future policy benefits and the deferral and amortization of acquisition costs.
Revenues for annuities and interest sensitive life insurance contracts consist of policy fees and charges for the cost of insurance, policy administration and surrenders that have been assessed against policyholder account balances during the period. Policy claims and benefits in excess of related policyholder account balances are charged to expense.
Deferred Acquisition Costs
The costs of acquiring new business are deferred as acquisition costs and amortized. For acquisitions of in force blocks of business and stock acquisitions accounted for as purchases, such costs represent the excess of the liabilities assumed over the net assets received. For new reinsurance, such costs are those which vary with and are directly related to the production of new business, principally commissions. Costs deferred in connection with traditional life insurance products are amortized over the premium paying period of the related policies using assumptions consistent with those used to compute future policy benefits. For annuities and interest sensitive life insurance products, acquisition costs are amortized generally in proportion to the present value of expected gross profits from such products. Amortization is adjusted when current estimates of future gross profits are revised.
Policy Benefit Liabilities
Future policy benefits under traditional long-term and group life insurance contracts have been computed based upon expected investment yields, mortality, persistency and other assumptions. These assumptions include a margin for adverse deviation and vary with the characteristics of the plan of insurance, year of issue, age of insured and other appropriate factors. Mortality and persistency assumptions are based on the Company's experience as well as industry experience and standards.
Future policy benefits for annuities and interest sensitive life insurance contracts are recorded at accumulated policyholder account values.
Policy claims include amounts determined on an individual case basis for reported claims and estimates of incurred but not reported claims developed on the basis of past experience.
Federal Income Taxes
The Company accounts for income taxes using the liability method. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial reporting and tax bases of assets and liabilities calculated using the tax rate in effect at the measurement date.
Stock Options
Prior to their cancellation (Note 3), the Company accounted for its stock options under Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and related Interpretations. Under APB 25, the Company did not incur any expense from the issuance of stock options because the exercise price of the option equaled the market price of the underlying stock on the date of grant.
Earnings Per Share
Earnings per share are not required to be presented in the financial statements of wholly owned subsidiaries.
New Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities ("SFAS 133"). The Company does not expect the implementation of SFAS 133 will have a significant impact on its financial statements.
3. MERGER
On December 1, 1998, Swiss Re acquired all of the outstanding common shares of Life Re Corporation for $95.00 per share. Additionally, consideration equal to the excess of $95.00 over the exercise price of each option was paid in exchange for the cancellation of all outstanding common stock options. The total cash purchase price was $1,801,151. Pursuant to the Merger, the Company became a wholly owned indirect subsidiary of Swiss Re. Costs incurred by the Company related to the Merger, primarily severance payments to certain executives and employees and compensation arrangements triggered by the Merger, are separately stated in the consolidated statement of operations and comprehensive income. Concurrently with the Merger, the Company received a capital contribution of $207,600 from Swiss Re and repaid all outstanding bank loans.
4. ACQUISITIONS AND REINSURANCE TRANSACTIONS
The following table summarizes the acquisitions and in force reinsurance transactions completed by the Company during the three years ended December 31, 1998. These transactions were accounted for as purchases and therefore results of operations include their effects only from their respective dates of acquisition. Significant transactions are further discussed below.
Effective June 30, 1998, the Company acquired, for a purchase price of $70,834, 100% of the common stock of Capitol Bankers Life Insurance Company ("Capitol Bankers"), an indirect subsidiary of The Manufacturers Life Insurance Company. The fair values of the assets acquired and liabilities assumed were approximately $183,148 and $118,210, respectively.
During 1998, the Company acquired, and merged into REALIC, Atlas Life Insurance Company and Aristar Life Insurance Company. The purchase price of these companies was $29,338 and $22,890, respectively. Together they had assets at fair value of $240,200 and liabilities of $188,241.
Effective February 28, 1998, the Company acquired, for a purchase price of $61,596, 100% of the common stock of Mission Life Insurance Company ("Mission"). The fair values of assets acquired and liabilities assumed were $258,982 and $199,586, respectively. Effective December 22, 1998, Mission acquired, for a purchase price of $17,552, 100% of the common stock of First Capital Life Insurance Company of Louisiana with assets at fair value of $85,364 and liabilities of $67,812. The primary business of these companies is insurance for final expenses. The Company also acquired a 20% interest in Mission Life Insurance Company of America which writes this type of business, substantially all of which is reinsured by the Company.
On September 30, 1997, the Company acquired a 79% interest in AML through the purchase of 79% of the common stock of AML's parent company, AML Acquisition Company, for a purchase price of $13,034. In conjunction with the purchase, the Company repaid $9,800 of long-term debt of AML Acquisition Company. The assets acquired had a fair value of $145,268 and the liabilities assumed aggregated $132,234.
Effective April 1, 1998, the Company acquired, for a purchase price of $46,600, 100% of the common stock of Lincoln Liberty Life Insurance Company and First Delaware Life Insurance Company from First Lincoln Holdings, Inc. and merged them into AML. The combined fair values of the assets acquired and the liabilities assumed were $242,196 and $195,472, respectively.
During 1996, the Company acquired and merged into REALIC three life insurance companies with assets at fair value of $302,409 and liabilities of $263,267. The total purchase price was $39,142.
During 1998, the Company entered into several indemnity reinsurance agreements pursuant to which the Company acquired existing blocks of in force business with liabilities for future policy benefits amounting to $50,199.
Effective December 30, 1997, the Company entered into an indemnity reinsurance agreement to coinsure 60% of a block of life insurance policies and annuity contracts coinsured by Employers Reassurance Corporation ("ERAC") from Allianz Life Insurance Company of North America. The Company simultaneously retroceded to ERC Life Insurance Company ("ERC Life"), a subsidiary of ERAC, on a modified coinsurance basis, 67% of the business assumed. The Company recorded a liability for policy benefits aggregating $683,345 and received assets, primarily fixed maturities, with a fair value of $652,019. The Company is required to maintain assets in a trust at least equal to the statutory reserves reinsured. The trust assets are managed by the Company's primary investment manager and are included in total investments in the accompanying balance sheet. The Company administers the entire block using a third party administrator. During 1998, the Company recaptured the business retroceded to ERC Life.
Effective July 1, 1997, the Company entered into an indemnity reinsurance agreement with life insurance subsidiaries of UNUM Corporation to coinsure and administer a block of insurance in force with liabilities for policy benefits under life insurance and annuity contracts totaling $117,622. Assets, principally cash, totaling $108,122 were transferred to the Company.
Effective May 31, 1996, REALIC acquired a block of insurance in force under an assumption reinsurance agreement with United Insurance Company of America, a subsidiary of Unitrin, Inc., whereby it assumed liabilities for future policy benefits totaling $124,245. Assets totaling $107,334, principally cash, were transferred to REALIC by the ceding company.
On March 4, 1999, the Company announced that it has entered into an agreement to acquire 100% of the common stock of Royal Maccabees Life Insurance Company and its wholly owned subsidiary, Royal Life Insurance Company of New York (collectively "Royal"), from Royal Sun Alliance Group plc for approximately $380,000. Royal has statutory assets of approximately $2,600,000. Its business consists primarily of individual and group life, annuities and disability income contracts. The transaction, which is subject to regulatory and other approvals, is expected to close during the second or third quarter of 1999.
In December 1998, the Company entered into an agreement, subject to regulatory approval, to acquire 100% of LSL Financial Corporation, parent of Lone Star Life Insurance Company ("Lone Star Life"), for approximately $49,000. As of December 31, 1998, Lone Star Life had statutory assets of approximately $528,000 and capital and surplus of approximately $35,000. Its business consists principally of individual disability income and individual life insurance contracts. This transaction is expected to close in the first quarter of 1999.
5. POLICY REVENUES AND ACQUISITION COSTS
Policy revenues are as follows:
Changes in deferred acquisition costs are as follows:
Deferred acquisition costs are amortized with interest at rates ranging from 5.3% to 8.7% except for the amount attributable to the acquisition of LRCA which is amortized with interest at 15%. The percentage of deferred acquisition costs which is expected to be amortized in each of the next five years is 14.2%, 13.0%, 11.8%, 10.8%,and 10.2% and the percentage expected to be amortized in each of the next five years, net of interest accretion, is 7.9%, 7.2%, 6.5%, 6.0%, and 5.7%.
6. INVESTMENTS
Securities with a fair value of $101,182 at December 31, 1998 are owned by a ceding company and held in a dedicated portfolio in conjunction with an indemnity reinsurance agreement. Under the terms of the agreement, investment income, realized gains and losses and all other risks and rewards of ownership of the assets in the portfolio inure to the benefit or detriment of the Company. Accordingly, these assets, consisting of $96,922 of fixed maturities and $1,018 of equity securities classified as available for sale and $3,242 of short-term investments at December 31, 1998, have been included as investments in the accompanying balance sheet. The portfolio is managed by the Company's primary investment advisor under guidelines approved by both parties to the reinsurance agreement, subject to the requirement that the statutory carrying value of the assets in the dedicated portfolio must be maintained by the Company in an amount at least equal to the statutory reserves on the reinsured business.
Securities with a fair value of $146,550 at December 31, 1998 were on deposit with various governmental insurance regulatory agencies to comply with applicable insurance laws.
Net unrealized appreciation of available for sale securities is as follows:
The amortized cost, unrealized gains and losses and estimated fair values of available for sale securities are as follows (see Note 2 for a discussion of the fair value of financial instruments):
At December 31, 1998, the contractual maturities of investments in fixed maturities are as follows:
Investments in any entity in excess of ten percent of shareholder's equity at December 31, 1998, other than investments issued or guaranteed by the U.S. government, are as follows:
Major sources and related amounts of investment income are as follows:
The changes in unrealized gains (losses) on securities are as follows:
Realized investment gains are as follows:
On March 18, 1996, Life Re Corporation sold its equity investment in Nacolah Holding Corporation ("Nacolah"), the parent of North American Company for Life and Health Insurance, in connection with the acquisition of Nacolah by Sammons Enterprises, Inc. The Company received proceeds of $25,057 and recorded a realized investment gain of $13,540.
7. POLICY BENEFIT LIABILITIES
Policy benefit liabilities consist of the following:
The Company's accident and health insurance business is of short duration and generally claims are reported within a short period of time after incurral. There have been no material favorable or adverse developments affecting accident and health insurance claims reserves in 1998, 1997 or 1996.
8. INCOME TAXES
Through the date of the Merger, LRCA and LRCA's parent, TexasRe Life Insurance Company ("TexasRe"), filed a consolidated federal income tax return with Life Re Corporation and REALIC and AML filed separate federal income tax returns. Effective with the Merger, TexasRe files a consolidated federal life insurance return with its direct and indirect wholly owned subsidiaries, AML files a separate federal income tax return and Life Re Corporation files a consolidated federal income tax return with certain Swiss Re subsidiaries.
The provisions for federal income taxes are as follows:
The deferred income tax balances, included in other liabilities, are as follows:
At December 31, 1998, income taxes recoverable of $29,419, included in other assets, reflect a refund anticipated from the carryback of tax operating losses generated in 1998 primarily from Merger related compensation and cancellation consideration for non qualified stock options as well as reinsurance ceding allowances. Life insurance company operating losses of approximately $205,000 are available for carryforward which generally expire after 15 years. The Company has performed an actuarial valuation which indicates that its existing business will generate income in the carryforward period sufficient to utilize the operating losses. Therefore no valuation allowance has been established. In 1998, the provision for federal income taxes of $24,003 differed from an expected tax benefit of $2,946 based on the statutory rate of 35% primarily due to certain non-deductible Merger compensation payments. In 1996, the realized gain on the sale of Nacolah (Note 6) and other income triggered the utilization of tax net operating loss carryforwards available to Life Re Corporation and a corresponding reversal of the previously established deferred tax valuation allowance, resulting in a tax benefit of $4,775. This reduced the effective income tax rate in 1996 to 29%.
9. LOANS PAYABLE AND CORPORATION-OBLIGATED, MANDATORILY REDEEMABLE CAPITAL SECURITIES OF SUBSIDIARY TRUSTS HOLDING SOLELY PARENT DEBENTURES
On December 1, 1998 in conjunction with the Merger (Note 3), the Company repaid all outstanding bank loans. Interest paid on bank loans was $7,768, $8,083 and $8,774 in 1998, 1997 and 1996, respectively.
On June 6, 1997, the Company completed a private placement under Rule 144A of the Securities Act of 1933, as amended, of $100,000 of 8.72% capital securities of Life Re Capital Trust I ("Trust I"), a subsidiary of the Company. Distributions are cumulative and payable in arrears beginning December 15, 1997. The securities have a maturity date of June 15, 2027 and may be redeemed, at the option of the Company, at any time on or after June 15, 2007. Payments on the securities are fully and unconditionally guaranteed by the Company. The securities have an effective interest rate of 8.75%.
On March 17, 1998, the Company, through Life Re Capital Trust II ("Trust II"), completed a public offering of 2,070,000 6% Adjustable Conversion-rate Equity Security Units ("Units") (the "Units Offering"). The Units consist of Quarterly Income Preferred Securities ("QUIPS") and a forward purchase contract (the "Contract") for the Company's common stock. The QUIPS have a maturity of March 15, 2003 and are subject to a put option by the QUIPS holder on either March 15, 2001 or June 15, 2001 and the Contract matures on March 15, 2001. Because of the Merger, the Contract redemption rate became fixed at $95.00 and the Units ceased to trade publicly. Payments on the Units are fully and unconditionally guaranteed by the Company. As a result of the Merger, the aggregate payment to Unit holders (net of the amount paid by Unit holders to the Company under the Contracts) will be approximately $24,600 million.
The assets of Trust I and Trust II consist of junior subordinated debentures issued by Life Re Corporation which have terms that parallel the terms of the capital securities. The Trusts are accounted for as wholly owned subsidiaries of the Company.
10. SHAREHOLDER'S EQUITY
Concurrently with the Units Offering (Note 9), on March 17, 1998, the Company completed a public offering in which it sold 3,500,000 shares of common stock (the "Common Stock Offering"). The net proceeds of the Common Stock Offering and the Units Offering totaled $352,297 of which $207,000 was contributed to the insurance subsidiaries.
Pursuant to a stock repurchase program approved by the Company's Board of Directors, 2,150,400 shares of common stock out of a total authorization of 3,000,000 shares were acquired through December 31, 1997 for a total purchase price of $46,647. In conjunction with the Common Stock and Units Offerings, the Board of Directors elected to discontinue the stock repurchase program. The treasury stock was retired effective with the Merger.
The Merger was effected by the conversion of each outstanding common share into consideration of $95.00 and a concurrent recapitalization whereby Swiss Re, through its wholly owned subsidiaries, became the sole holder of the Company's preferred and common stock consisting of 1,000 and 100 shares, respectively. The preferred stock has no dividend rights and a liquidation preference at par value.
In January 1999, pursuant to its Restated Certificate of Incorporation, the Company issued 10,000 shares of preferred stock with a par value of $.01 to its parent in exchange for a promissory note in the amount of $615,000 which bears interest at 5% payable annually in arrears beginning December 31, 1999. The note may be prepaid at any time and is due on December 31, 2008.
As of the Merger date, all outstanding common stock options vested and were cancelled in exchange for consideration equal to the excess of $95.00 over the exercise price of each option. During 1998, prior to the Merger, 582,000 options were granted at a weighted average exercise price of $64.98 and 166,650 options were exercised.
Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based Compensation" ("SFAS 123"), requires disclosure of pro forma information regarding net income and as if the Company had accounted for its employee stock options under the fair value method of SFAS 123. This method provides for employee stock options to be measured at fair value on the date of grant which is then amortized to expense over the options' vesting period. The fair value of the options for the pro forma disclosures which follow was estimated using a Black-Scholes option pricing model with the following assumptions for 1998, 1997 and 1996, respectively: risk-free interest rates ranging from 5.4% to 5.7%, 6.3% to 6.4% and 5.4% to 6.8%, respectively; dividend yields of 1.0% in each year; volatility factors of the expected market price of the Company's common stock of 20% in 1998 and 1997 and 25% in 1996; and weighted-average expected life of the options of 5 years.
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. Option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options had characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models did not necessarily provide a reliable single measure of the fair value of its employee stock options.
Pro forma net income (loss) including the effects of amortization of the estimated fair values of stock options granted after December 15, 1994 is $(36,496), $47,256 and $53,116 for 1998, 1997 and 1996, respectively.
The availability of funds to meet obligations, including, capital security distributions is dependent, in part, on the ability of its subsidiaries to transfer funds to Life Re Corporation. The subsidiaries are subject to certain state laws and regulations which limit their ability to transfer funds and pay dividends. Generally, the
subsidiaries may not, without prior regulatory approval, transfer cash dividends, loans or advances in any twelve month period in excess of the greater of the prior year's statutory operating income or 10% of capital and surplus at the preceding year end. Additionally, under Connecticut law, no dividend in an amount exceeding LRCA's earned surplus may be transferred to TexasRe without prior regulatory approval. Approval has been received from the Connecticut Department of Insurance to define earned surplus for this purpose to include amounts of paid in surplus in excess of $125,000. At December 31, 1998, net assets of TexasRe totaling $113,130 are not available for transfer to Life Re Corporation in 1999 except with prior approval of state regulatory authorities. Dividends paid to Life Re Corporation by TexasRe were $0 in 1998, $16,314 in 1997 and $12,087 in 1996.
Life Re Corporation owns $160,500 of surplus debentures issued by TexasRe which provide funds to Life Re Corporation in the form of principal and interest payments. Under the terms of an amendment to TexasRe's surplus debentures, no prior approval of the Texas Department of Insurance is required to pay or prepay scheduled principal or interest on the surplus debentures provided that, after giving effect to any such payment, the statutory surplus of TexasRe exceeds $125,000. The amendment to TexasRe's surplus debentures was approved under the consideration that statutory surplus, as defined, in excess of $125,000 be reflected in liabilities to the extent of outstanding surplus debenture interest and principal. Payments of surplus debenture interest to Life Re Corporation by TexasRe totaled $9,237, $9,799 and $10,008 in 1998, 1997 and 1996, respectively.
The subsidiaries' statutory basis financial statements are prepared in accordance with accounting practices prescribed or permitted by their respective domiciliary states. "Prescribed" statutory accounting practices include state laws, regulations and general administrative rules, as well as publications of the National Association of Insurance Commissioners ("NAIC"). "Permitted" statutory accounting practices encompass all accounting practices that are not prescribed; such practices may differ from state to state, may differ from company to company within a state and may change in the future. The Company does not utilize any permitted accounting practices. The NAIC currently is in the process of codifying statutory accounting practices. That project, when completed, may change prescribed statutory accounting practices and thus may result in changes to the accounting practices that the subsidiaries use to prepare their statutory basis financial statements.
The combined statutory basis financial position of TexasRe and subsidiaries as of December 31, 1998 and 1997 is as follows:
- --------------- * Represents the elimination of intercompany balances.
Combined statutory basis net loss for TexasRe and subsidiaries was $159,319 and $54,121 in 1998 and 1997. In 1996, TexasRe and subsidiaries had combined statutory basis net income of $16,315.
11. EMPLOYEE BENEFIT PLANS
Substantially all full time employees are covered by a noncontributory defined benefit pension plan. Benefits are determined by a formula which relates the pension payable to years of service at retirement, final five year average salary and wages covered by Social Security. Annual contributions to the plan are sufficient to satisfy legal funding requirements. In addition, the Company has an unfunded Supplemental Executive Retirement Plan which is a nonqualified plan that provides certain officers defined pension benefits in excess of limits imposed by federal tax law. The Company also sponsors a defined contribution savings plan covering substantially all employees with at least six months of service. The Company contributes 50% of the first 6% of salary contributed by employees. Participants vest in Company contributions over a four year period. The combined expense associated with employee benefit plans was $761, $1,438 and $1,151 in 1998, 1997 and 1996, respectively.
12. REINSURANCE CEDED
In the normal course of business, the Company seeks to limit its exposure to loss by ceding reinsurance to retrocessionaires. In general, the Company retains a maximum of $1,000 on any one life for ordinary life insurance business with certain limited exceptions depending upon age and classification of the risk. Amounts in excess of the retention are ceded to a pool of retrocessionaires. From time to time, the Company has also entered into quota share retrocessional agreements. In general, the Company's policy in regard to group insurance business is to retain not more than $250 of liability on any one life insurance risk, $300 on any one accident or health insurance risk or, for special risk insurance, $1,000 on any one risk. The Company has agreements with group retrocessionaires primarily on an excess basis. Contracts for reinsurance ceded do not relieve the Company from its obligations under contracts for reinsurance assumed. Failure of retrocessionaires to honor their obligations could result in losses to the Company; however, no amounts are deemed uncollectible at December 31, 1998.
The Company's policy generally is to require collateral from those retrocessionaires not authorized to conduct reinsurance business in Connecticut, LRCA's domiciliary state, in an amount at least equal to the statutory reserves reinsured. Collateral is provided in the form of letters of credit and trust agreements.
Amounts receivable on reinsurance ceded are as follows:
Policy benefits recovered on reinsurance ceded for the years ended December 31, 1998, 1997 and 1996 were $306,393, $107,309 and $75,971, respectively.
13. BUSINESS SEGMENT INFORMATION
The following table presents summarized data for the Company's business segments. One client within traditional reinsurance comprised over 10% of policy revenues in 1998.
LIFE RE CORPORATION AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT SCHEDULE II
LIFE RE CORPORATION BALANCE SHEETS (PARENT COMPANY)
- --------------- (1) Eliminated in consolidation.
The condensed parent company financial statements should be read in conjunction with the consolidated financial statements of Life Re Corporation and Subsidiaries included elsewhere herein.
LIFE RE CORPORATION AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT SCHEDULE II -- CONTINUED
LIFE RE CORPORATION STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (PARENT COMPANY)
- --------------- (1) Eliminated in consolidation.
The condensed parent company financial statements should be read in conjunction with the consolidated financial statements of Life Re Corporation and Subsidiaries included elsewhere herein.
LIFE RE CORPORATION AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT SCHEDULE II -- CONTINUED
LIFE RE CORPORATION STATEMENTS OF CASH FLOWS (PARENT COMPANY)
- --------------- (1) Eliminated in consolidation.
The condensed parent company financial statements should be read in conjunction with the consolidated financial statements of Life Re Corporation and Subsidiaries included elsewhere herein.
ITEM 9
ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10
ITEM 10 DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS
Set forth below is biographical information concerning each Director, including as to each Director, the Director's principal occupation and the period during which the nominee has served as a Director of the Company. Ages shown are as of December 31, 1998.
F. SEDGWICK BROWNE (56) DIRECTOR SINCE 1998
From 1994 to the present, Mr. Browne has served as a Partner of Morgan, Lewis & Bockius LLP. From 1967 to 1994 he was a partner at Lord Day & Lord, Barrett Smith. Mr. Browne is a graduate of Yale University and the University of Pennsylvania Law School.
JOHN R. COOMBER (49) DIRECTOR SINCE 1998
Mr. Coomber is a graduate of Nottingham University, where he studied theoretical mechanics. He started his career in insurance as an actuarial trainee with the Phoenix Insurance Company and in 1973 moved to Swiss Reinsurance Company (UK). Having qualified as an actuary in 1974, he became involved in all aspects of Swiss Re's life reinsurance activities, namely pricing, valuation, marketing and administration.
He was Swiss Re UK's Appointed Actuary from 1983 to 1990, and was appointed General Manager and head of the Life division in 1987. He became Director and CEO of Swiss Re (UK) in January 1993.
In April 1995 he was appointed a Member of the Executive Board of Swiss Re. He is currently divisional chief executive of Swiss Re Life & Health.
CHRISTOPH DORSCHEL (60) DIRECTOR SINCE 1998
Mr. Dorschel studied law. In January 1993 he was appointed Member of Swiss Re's Group Management, responsible for the Group's Finance division. Since April 1995 he has been a Member of the Executive Board Committee, responsible for human and financial resources; since March 1997 for human resources, law and logistics.
In February 1998, he assumed the functions of Chief Finance Officer in addition, on an interim basis. As from July 1998, he is entrusted with special assignments.
JACQUES E. DUBOIS (49) DIRECTOR SINCE 1988
Mr. Dubois has served as President and Director of the Company since November 1988 and Chairman and Chief Executive Officer since March 1999. Mr. Dubois also serves as Chief Executive Officer of Life Reassurance, REALIC and of AML. In addition, Mr. Dubois was associated with Insurance Investment Associates from 1979 to 1998.
GEORGE L. FARR (57) DIRECTOR SINCE 1999
Mr. Farr is presently retired. From 1995 to 1998 Mr. Farr served as Vice Chairman of American Express Co. and from 1968 to 1995 he served as Director of McKinsey & Co. and Mr. Farr is a graduate of University of Michigan, where he earned his B.A. and M.B.A.
THOMAS H. FOX (56) DIRECTOR SINCE 1998
Mr. Fox is presently retired. From 1966 to 1993, he held various positions at JP Morgan & Co. Incorporated. At the time of his retirement, he was a Managing Director. Mr. Fox is a graduate of the University of Notre Dame and received an M.B.A. from the University of Michigan.
HEIDI E. HUTTER (41) DIRECTOR SINCE 1998
Ms. Hutter is Chairman, President and Chief Executive Officer of Swiss Re America Corporation. She received her B.A. degree in mathematics from Cornell University.
Ms. Hutter began her career with the Swiss Re Group in the actuarial department, later specializing in financial and finite risks. She left the Swiss Re Group in October 1993, and headed the "Equitas" project at Lloyd's of London until December 1995, developing ways of reinsuring all business written at Lloyd's in 1992 and prior years.
Ms. Hutter took over responsibility for Swiss Re America in January 1996, becoming a Member of the Swiss Re Executive Board at the same time. In July 1996, Ms. Hutter was also appointed CEO of Swiss Re America Holding Corporation and in January 1997, she assumed responsibility for Swiss Re Canada. She is a Fellow of the Casualty Actuarial Society and has served on its Board of Directors. Ms. Hutter was named APIW Insurance Woman of the year in 1995 and received the Federation of Insurance and Corporate Counsel's Award in 1996.
WALTER B. KIELHOLZ (47) DIRECTOR SINCE 1998
Mr. Kielholz studied business administration at the University of St. Gall, Switzerland, graduating in 1976 with a degree in business finance and accounting.
He joined Swiss Re at the beginning of 1989 as head of the Japan and Far East section, where he was responsible for coordinating marketing and for underwriting property and casualty business. At the beginning of 1992 he was also assigned responsibility for the head office's reinsurance business in the USA and the UK. In January 1993 he became a Member of the Executive Board of Swiss Re, Zurich. Since April 1995, he has been a Member of the Executive Board Committee, responsible for the alternative Risk Transfer division.
He became Swiss Re's Chief Executive Officer on January 1, 1997.
At the Annual General Meeting of June 26, 1998, the shareholders elected him to the Board of Directors. In the subsequent inaugural meeting of the Board of Directors he was appointed Managing Director.
WILLIAM L. MUSSER, JR. (56) DIRECTOR SINCE 1998
Mr. Musser has served as President of William L. Musser Co., Inc. from 1995 to the present. From 1989 to 1995 he was a Partner at Barker, Lee & Co. Mr. Musser is a graduate of Princeton University (A.B) and Harvard Business School (M.B.A.).
JAY A. NOVIK (54) DIRECTOR SINCE 1998
From January 1998 to January 1999, Mr. Novik served as Vice Chairman of Swiss Re America Holding; from 1983 to 1998 he served as President of Atrium Corp.; from 1982 to 1988 he was Vice Chairman of North American Reinsurance Co. and from 1978 to 1982 he was an Actuary North American Reassurance Co. Mr. Novik is a graduate of Temple University and Northeastern University.
STANLEY TABEN (66) DIRECTOR SINCE 1998
From 1972 to the present, Mr. Taben has served as Chairman, President and Director of Swiss Re Investors. Mr. Taben is a graduate of Cornell University.
N. DAVID THOMPSON (64) DIRECTOR SINCE 1998
Mr. Thompson is retired. Mr. Thompson is the former Chairman and Chief Executive Officer of Swiss Re America Holding Corp. having served from 1977 to 1997. Mr. Thompson is a graduate of Wesleyan University and Columbia University.
CHARLES G. WATSON (67) DIRECTOR SINCE 1998
Mr. Watson is presently retired and was formerly a partner and Senior Investment Counsel of Brundage, Story & Rose. Mr. Watson received a B.A. from Yale University and had post graduate education at the Stern School of Business of New York University.
ERWIN K. ZIMMERMAN (45) DIRECTOR SINCE 1998
Mr. Zimmermann read social sciences at the University of Constance, where he completed his doctorate.
At the beginning of 1990, Mr. Zimmermann began his employment with Swiss Re as head of corporate development in the former direct insurance division. His nomination to senior management followed in 1992. Later the same year, he was elected to the Board of Directors of Savoia Assicuranzioni S.p.A., where he took over as Chairman the following year.
In 1995, Mr. Zimmermann joined the Run-off department in Zurich, becoming head of that department in 1996. In January 1997 he was appointed to the Executive Board of Swiss Re, Zurich and Chief Executive Officer of Swiss Re New Markets, Zurich.
EXECUTIVE OFFICERS
DAVID J. WALSH (49)
Mr. Walsh serves as Senior Vice President and General Counsel of the Company. Mr. Walsh has served as Senior Vice President, General Counsel & Corporate Secretary of Swiss Re America Holding Corporation since October 1998. He served as General Counsel from January 1995 to June 1998 for American International Group. He was the Director of Insurance for the State of Alaska from February 1990 to January 1995.
ALAN D. HEAD (42)
Mr. Head has served as Vice President and Chief Financial Officer since December 1998. Mr. Head has also served as Executive Vice President and Chief Financial Officer of Life Reassurance since December 1998, its Senior Vice President and Controller since January 1998 and as its Vice President since January 1994. Mr. Head has also served as Vice President and Chief Financial Officer of REALIC since December 1998 and as its Assistant Secretary since August 1995.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Pursuant to Section 16(a) of the Securities Exchange Act of 1934, as amended, the Company's directors, executive officers and certain other officers are required to file reports of ownership and changes in ownership of the Company's securities with the Securities and Exchange Commission and the New York Stock Exchange. Copies of such reports also must be provided to the Company.
Based solely upon a review of the copies of the reports provided to the Company and written representations from certain persons that no other reports were required, the Company believes that during the preceding year the directors, executive officers and certain other officers complied with all applicable filing requirements.
ITEM 11
ITEM 11 EXECUTIVE COMPENSATION
LIFE RE CORPORATION
SUMMARY COMPENSATION TABLE
- --------------- (1) Positions are at Life Re Corporation unless otherwise noted.
(2) Mr. Stroup and Mr. Beisenherz joined the Company in June and May of 1996, respectively, and therefore their respective salaries shown for 1996 only cover the period from their hire dates through December 1996.
(3) The 1996, 1997 and 1998 LTIP Payouts for Mr. Dubois were determined in accordance with the terms of the Life Re Corporation Long-Term Incentive Plan. All of the 1996 LTIP Payouts related to (i) the acquisition of a block of insurance from United Insurance Company of America ("United"), (ii) the investment in Resource Financial Corporation and certain of its affiliates ("RFC") and reinsurance arrangements with RFC and affiliates of Aon Corporation, (iii) the acquisitions of Modern American Life Insurance Company ("Modern"), Western Pioneer Life Insurance Company ("Western") and New American Life Insurance Company ("New American") and (iv) the sale at a gain of the Company's investment in Nacolah Holding Corporation ("Nacolah"); all of the 1997 LTIP Payouts related to (i) the reinsurance of a block of business from a subsidiary of UNUM Corporation ("UNUM"), (ii) the acquisition of 79% of the common stock of AML Acquisition Company, the owner of AML, (iii) the reinsurance of a block of business from Allianz Life Insurance Company of North America ("Allianz"), and (iv) reinsurance arrangements with RFC and certain of its affiliates; and all of the 1998 LTIP Payouts related to (i) the acquisition of Mission Life Insurance Company; (ii) the acquisition of Lincoln Liberty Life Insurance Company and First Delaware Life Insurance Company, (iii) the reinsurance of an additional 20% of the block of business from Allianz, (iv) the acquisition of
Atlas Life Insurance Company, (v) the coinsurance agreement with CNA Financial Corporation, (vi) reinsurance arrangements with RFC and certain of its affiliates, and (vii) the Merger.
(4) Represents Company matching contributions under the 401(k) defined contribution plan (in 1998: $4,800 each for Messrs. Dubois, Stroup, Beisenherz, Wilson and Head; in 1997: $4,750 each for Messrs. Dubois, Stroup, Beisenherz and Wilson, and $3,400 for Mr. Head; in 1996: $4,750 each for Messrs. Dubois and Wilson, and $3,264 for Mr. Head), life insurance premiums (in 1998: $5,962 for Mr. Dubois, $1,334 for Mr. Stroup, $4,897 for Mr. Beisenherz, $1,313 for Mr. Wilson and $1,187 for Mr. Head; in 1997: $4,835 for Mr. Dubois, $1,218 for Mr. Stroup, $4,897 for Mr. Beisenherz, $1,141 for Mr. Wilson and $826 for Mr. Head; in 1996: $4,698 for Mr. Dubois, and $770 for Mr. Stroup, $3,360 for Mr. Beisenherz, $1,116 for Mr. Wilson and $787 for Mr. Head), excise tax gross-up amounts related to the Merger (in 1998: $3,897,896 for Mr. Dubois, $1,603,486 for Mr. Stroup, $1,385,055 for Mr. Beisenherz, and $1,352,874 for Mr. Wilson), the value of stock options exercised related to the Merger ($30,055,625 for Mr. Dubois, $10,596,563 for Mr. Stroup, $10,671,563 for Mr. Beisenherz, $10,515,000 for Mr. Wilson and $1,753,906 for Mr. Head), and the value of shares of common stock that became vested upon the forgiveness of a non-recourse note (in 1998: $520,219 for Mr. Wilson).
(5) A portion of the bonuses paid in 1998 to Messrs. Stroup, Beisenherz and Wilson in the amount of $2,391,507 each, in 1997 in the amount of $172,717 each, and in 1996 in the amounts of $96,235, $142,477 and $142,477, respectively, were special bonuses paid in accordance with their employment agreements or arrangements which provided for bonuses upon the completion of the 1998 transactions, the 1997 transactions and certain of the 1996 transactions noted in footnote (3) above, except 1996 bonuses paid to Messrs. Beisenherz and Wilson did not include the Nacolah transaction, and the 1996 bonus for Mr. Stroup did not include the Nacolah, United, Modern and Western transactions.
LIFE RE CORPORATION
OPTION/SAR GRANTS IN LAST FISCAL YEAR
- --------------- (1) Positions are at Life Re Corporation unless otherwise noted.
(2) Only stock options were granted, which were scheduled to vest over four years at a rate of 25% per year with initial vesting on January 2, 1999.
(3) Option values are determined using the Black-Scholes option pricing model adapted for use in valuing executive stock options. The values are based on assumptions regarding a number of variables for the term of an option such as interest rates, future volatility of the price of Common Shares, and the Company's future dividend yield. Therefore, there can be no assurance that the values realized upon exercise of options by the named executive officers will be at or near the values estimated by the Black-Scholes model.
LIFE RE CORPORATION
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR END OPTION/SAR VALUES
- --------------- (1) Positions are at Life Re Corporation unless otherwise noted.
LONG-TERM INCENTIVE PLANS -- AWARDS IN LAST FISCAL YEAR
The Company has not included a Long-Term Incentive Plan table because future payments under the Life Re Corporation Long-Term Incentive Plan ("LTIP"), which terminated on December 1, 1998, are not expected at this time. The Company has provided the following narrative description of the LTIP:
Mr. Dubois was previously eligible to participate in the LTIP. Such executive officer was granted one unit under the LTIP. Such unit entitled the holder, upon the attainment of performance goals as established by the Compensation Committee of the Board of Directors and the closing of the transaction related to the performance goal, to receive a portion of the Bonus Pool (as defined in the LTIP) as a cash lump sum payment. The value of each unit was equal to the total amount allocated to the Bonus Pool, multiplied by a fraction, the numerator of which was one, and the denominator of which was the total number of units which were granted with respect to such Bonus Pool.
The Bonus Pool established upon the closing of a transaction by the Company was equal to (i) 2% of the amount involved in connection with any eligible acquisition or merger with another entity, (ii) 2% of the amount involved in connection with any eligible acquisition of a block of insurance in force, and (iii) 5% of the amount involved in connection with a recognition of capital gains upon the sale of an eligible investment.
In 1998, LTIP payments were made as a result of the successful achievement of performance goals, which resulted in (i) the acquisition of Mission Life Insurance Company, (ii) the acquisition of Lincoln
Liberty Life Insurance Company and First Delaware Life Insurance Company, (iii) the reinsurance of an additional 20% of the block of business from Allianz, (iv) the acquisition of Atlas Life Insurance Company, (v) the coinsurance agreement with CNA Financial Corporation, (vi) reinsurance arrangements with RFC and certain of its affiliates, and (vii) the Merger. The 1998 LTIP payments for Mr. Dubois were $7,246,990. Future LTIP payments are not expected at this time.
EMPLOYEE BENEFIT PLANS
Savings Plan. The Life Reassurance Corporation of America and Its Affiliates Employee Savings Plan (the "Savings Plan") is a defined contribution plan that is qualified under Sections 401(a) and 401(k) of the Code. Employees of the Company and its subsidiaries who have completed six consecutive months of service and attained age twenty-one are eligible to participate in the Savings Plan. Under the Savings Plan, each participant is eligible to enter into a written salary reduction agreement with the Company whereby the participant's salary will be reduced as elected by the participant on a pre-tax basis in accordance with the rules governing cash or deferred arrangements under Section 401(k) of the Code, with the total reduction not exceeding $10,000 for 1999. The amount deferred by a participant is contributed to the trust fund for the Savings Plan and invested in accordance with the election of the participant from among investment funds established under the trust agreement in accordance with Section 404(c) of the Code. The Company makes a contribution to the Savings Plan trust fund equal to 50% of the participant's pre-tax contributions that equal up to 6% of that participant's base salary. All employee contributions are 100% vested at all times. With respect to matching contributions by the Company, such contributions are 50% vested after two years of service, 75% vested after three years of service and 100% vested after four years of service with the Company. Participants' vested accounts under the Savings Plan are distributable after termination of employment. During employment, participants may withdraw funds from their accounts in the event of financial hardship as defined in the Savings Plan and permitted under the Code. The Code imposes various limits on the amounts which can be contributed to the Savings Plan by or for any participant each year. During the year ended December 31, 1998, the following matching contributions were made on behalf of the individuals named in the executive compensation table: $4,800 for each of Messrs. Dubois, Stroup, Beisenherz, Wilson and Head; and $24,000 for all named executive officers as a group.
Retirement Plan. The Company maintains the Employees' Retirement Plan of Life Reassurance Corporation of America and Its Affiliates (the "Retirement Plan"), which is a defined benefit pension plan qualified under Section 401(a) of the Code.
The table set forth below illustrates the approximate annual retirement benefits which would be payable at age 65 as a single life annuity, based on the Average Monthly Compensation and years of credited service indicated, under the Retirement Plan to participants whose benefits are determined by the Retirement Plan formula, before any reduction for benefits under any General Reassurance Corporation plan or for Social Security benefits. The values shown below reflect the change in tax law effective January 1, 1994 that limits the amount of annual compensation that may be taken into account under qualified plans, such as the Retirement Plan, to $150,000, indexed annually. For 1998, the amount of annual compensation that may be taken into account under qualified plans was $160,000.
PENSION PLAN TABLE
ESTIMATED ANNUAL RETIREMENT BENEFITS
With respect to each of the individuals named in the executive compensation table, the estimated credited years of service under the Retirement Plan as of December 31, 1998 were as follows: Mr. Dubois, ten years; Mr. Stroup, three years; Mr. Beisenherz, three years; Mr. Wilson, eight years; Mr. Head, five years and all named executive officers as of December 31, 1998 as a group, an average of six years.
Benefits are funded through employer contributions to a trust. Employees of the Company are eligible to participate in the Retirement Plan when they have completed one year of service and attained age twenty and one-half. Participants become vested in their benefits under the Retirement Plan as follows: 20% after three years' service, 40% after four, 60% after five, 80% after six, and 100% (fully) vested after seven years' service, subject to certain break-in-service rules. The Retirement Plan provides a benefit upon retirement at the normal retirement age of 65 which, when expressed as a single life annuity, equals (i) 1.5% of Average Monthly Compensation (as that term is defined in the Retirement Plan) multiplied by the number of the participant's years of service up to a maximum of thirty years, plus (ii) 0.3% of Average Monthly Compensation in excess of Social Security Retirement Benefits covered compensation multiplied by the participant's years of service up to a maximum of thirty years, less (iii) the amount of any accrued benefit provided under any defined benefit plan of General Reassurance Corporation for service prior to January 1, 1989. Average Monthly Compensation is the participant's average monthly compensation (excluding overtime pay and bonuses) for the five most highly compensated consecutive calendar years of service from the participant's date of hire to his or her date of termination of employment. A participant may elect to commence receiving benefits under the Retirement Plan when he or she has attained age 55 and completed ten years of service. Benefits under the Retirement Plan are normally payable in the form of a single life annuity in the case of unmarried participants and in the form of a joint and survivor annuity in the case of married participants. If a participant continues employment past Normal Retirement Age (as that term is defined in the Retirement Plan), his or her retirement benefit determined at the close of each Plan Year (as that term is defined in the Retirement Plan) prior to actual retirement is equal to the greater of (i) the actuarial equivalent of the monthly retirement benefit as of the close of the prior Plan Year, or (ii) his or her accrued benefit at the close of the Plan Year. This benefit is offset by any benefit distributions during the Plan Year. Sections 401(a)(17) and 415 of the Code limit both the amount of a participant's compensation that may be taken into account for purposes of calculating Average Monthly Compensation and the amount of benefits that may be paid from the Retirement Plan.
Supplemental Executive Retirement Plan. With certain exceptions, Section 415 of the Code currently limits pension benefits which may be paid under plans qualified under the Code to an annual benefit of $120,000, indexed annually. The Tax Reform Act of 1986 limits the amount of annual compensation which may be considered in determining qualified plan pensions to $150,000, indexed annually, effective January 1, 1994. Previously, the limit was $200,000, indexed annually. For 1998, the amount of annual compensation which could be considered in determining qualified plan pensions was $160,000. In March 1995 the Board of Directors, upon the recommendation of the Benefits Committee, established the Life Re Corporation Supplemental Executive Retirement Plan ("SERP") for certain designated officers of Life Re Corporation to whom these limits apply, or will apply in the future, so that these employees would obtain the benefit that would have applied in the absence of these limits, as well as to provide additional retirement benefits to a number of key executives whose many years of service in the industry prior to joining the Company would not be counted as years of service under the Retirement Plan.
The table set forth below illustrates the approximate annual retirement benefits which would be payable at age 62 based on the Average Monthly Compensation and years of credited service indicated under the SERP to participants whose benefits are determined by the SERP formula.
SUPPLEMENTAL EXECUTIVE RETIREMENT PENSION PLAN TABLE
ESTIMATED ANNUAL RETIREMENT BENEFITS
The SERP provides monthly supplemental benefits upon retirement equal to 2.5% of the participant's Average Monthly Compensation (as defined in the above described Retirement Plan) multiplied by the number of the participant's Years of Service (as defined under the Retirement Plan) less (i) 3.33% of Social Security Retirement Benefits multiplied by Years of Service and (ii) the amount of the monthly benefit provided under the Retirement Plan. Upon a Change in Control, Years of Service will automatically be increased by five years. The Merger constituted a Change in Control under the SERP and resulted in each participant's Years of Service increasing by five years.
The estimated annual benefits payable upon retirement at normal retirement age for each of the named executive officers designated under the SERP are $757,124 for Mr. Dubois, $677,717 for Mr. Stroup and $679,661 for Mr. Wilson. These amounts include an additional five years of service resulting from the Change in Control from the Merger.
Discretionary Bonus Plan. The Company's Bonus Plan (the "Discretionary Bonus Plan") previously provided individual awards based on annual performance goals. The Executive Committee of the Board of Directors evaluated qualitative performance and approved the list of participants. Individual awards for performance were determined by the Executive Committee and were paid during the first quarter after the close of the fiscal year to which the award pertained. No award was payable to a participant who terminated employment voluntarily or was terminated by the Company with or without cause prior to the payment date, except that a pro-rated award would be paid in the event of termination by reason of retirement, death or permanent disability. No awards were paid to the Company's five named Executive Officers under the Discretionary Bonus Plan for the 1996, 1997 and 1998 fiscal years. Award payments would be made in cash solely from general corporate assets. Awards under the Discretionary Bonus Plan do not meet the criteria for performance-based compensation, and therefore may not be deductible under the applicable rules and regulations of Section 162(m) of the Code.
Annual Plan. The Life Re Corporation Annual Incentive Plan (the "Annual Plan") previously provided annual cash bonuses to officers of the Company. Participants were the key executives of the Company selected by the Compensation Committee to participate in the Annual Plan prior to the start of each plan year. The amount of the awards, if any, were based on the attainment of certain performance objectives determined by the Compensation Committee including, without limitation, the future performance of the Company, the participant's level of responsibilities, performance, salary and other compensation. The performance objectives applicable to a plan year were set prior to the beginning of that plan year and were related to measures of the Company's performance such as profitability and growth. The participants were assigned an impact level determined in the discretion of the Compensation Committee. The performance
objectives and the benefits may have been different between and among impact levels. If a participant's employment terminated or there was a reduction in duties, title or position, within twelve months after a Change in Control, the participant would be entitled to a payment under the Annual Plan equal to the current year's pro-rata portion of the bonus amount earned in the previous year. The Board may alter, amend, suspend, or discontinue the Annual Plan, but participants' rights regarding outstanding awards may not be adversely affected. The Compensation Committee did not designate any officers of the Company as participants in the Annual Plan for 1999.
The Compensation Committee intends to administer the Annual Plan in accordance with the applicable rules and regulations under Section 162(m) of the Code.
Long-Term Plan. The Life Re Corporation Long-Term Incentive Plan (the "LTIP") previously provided cash bonuses to designated officers of the Company. Participants were selected by the Compensation Committee to participate in the LTIP prior to the start of each plan year. The amount of the awards, if any, were based on the attainment of certain performance goals set forth in the LTIP including, without limitation, acquisitions, mergers, and gains on the sale of certain investments. The Board may alter, amend, suspend, or discontinue the LTIP, but participants' rights regarding outstanding awards may not be adversely affected. The Compensation Committee did not designate any officers of the Company as participants under the LTIP for 1999. The participants and the percentage participation in the pool may change from year to year in the discretion of the Compensation Committee.
The Compensation Committee intends to administer the LTIP in accordance with the applicable rules and regulations under Section 162(m) of the Code.
Employment Agreements. Swiss Re has entered into new employment agreements with Messrs. Dubois, Stroup, Wilson and Beisenherz (the "Executives") as of July 27, 1998 (the "1998 Agreements"). The 1998 Agreements superseded the Executives' prior employment agreements (or severance agreement in the case of Mr. Beisenherz). The "Term" of the 1998 Agreements began on December 1, 1998 and terminates on December 31, 2001.
Each 1998 Agreement provides that the Executive's annual base salary will be increased as of January 1, 1999 (to $800,000 for Mr. Dubois and $400,000 for each of the other Executives), will be reviewed annually, and will not be reduced. Each Executive is eligible for an annual Performance Bonus to be calculated with respect to the increase in "Operational Embedded Value" (as defined in the 1998 Agreements) of the Administrative Reinsurance business of the Company and its subsidiaries. If the "Management Target" (as defined in the 1998 Agreements) is attained for a given year, the amount of the Performance Bonus for each Executive will be as follows: for 1999, $1.125 million; for 2000, $1.4 million; and, for 2001, $1.68 million. If the Management Target for a given year is at least 50% attained, but not fully attained, the Performance Bonus will be reduced ratably. If less than 50% of the Management Target is attained for a given year, no Performance Bonus will be paid for that year. If the Management Target for a given year is exceeded, the Executive's Performance Bonus will be increased ratably, up to the following maximum amounts: for 1999, $4.5 million; for 2000, $5.6 million; and for 2001, $6.72 million. The Executive also is eligible for a discretionary annual bonus reflecting group, division, Swiss Re and individual performance in a maximum amount equal to a percentage of annual base salary (100% as to Mr. Dubois and 83.33% as to the other Executives). Further, the Executive is eligible to receive annually a Special Bonus. If the Management Target is attained for any year during the Term, the Executive will receive a Special Bonus (equal to $4 million for Mr. Dubois and $1,333,400 for each of the other Executives), which will be reduced pro rata if the Management Target is not attained. If the Management Target for a given year is exceeded, the Executive's Special Bonus will be increased ratably, up to a maximum (of $8 million for Mr. Dubois and $2,666,800 for each of the other Executives) for attainment of 200% or more of the Management Target.
On December 1, 1998, the Executives were granted a number of restricted shares of Swiss Re common stock determined by dividing a certain amount ($8 million as to Mr. Dubois and $4 million as to each of the other Executives, as such amounts may be adjusted by the respective Executive and Swiss Re in good faith) by the closing price per share of the Swiss Re common stock on December 1, 1998. The restrictions on such shares will lapse on December 31, 2001, unless the Executive's employment is terminated earlier by Swiss Re
for "Cause" (as defined in the 1998 Agreement) or by the Executive without "Good Reason" (as defined in the 1998 Agreement). Either such termination will result in forfeiture of all such shares. If the Executive's employment is terminated before December 31, 2001, by the Company without "Cause", by the Executive with "Good Reason", by the Executive's death or by the Executive's "Disability" (as defined in the 1998 Agreement), all restrictions on such shares lapse and they become vested. The Executive will be eligible to receive discretionary annual stock option grants (with exercise prices equal to the fair market value of the underlying shares). Each annual grant is expected to cover shares having an aggregate fair market value equal to the then-current amount of the Executive's annual base salary. If the Executive's employment is terminated by the Company without "Cause", by the Executive with "Good Reason", by the Executive's death or by the Executive's Disability" (as defined in the 1998 Agreement), all restrictions on such shares lapse and they become vested.
The Executive will be eligible to receive discretionary annual stock option grants (with exercise prices equal to the fair market value of the underlying shares). Each annual grant is expected to cover shares having an aggregate fair market value equal to the then-current amount of the Executive's annual base salary. If the Executive's employment is terminated by the Company without "Cause", by the Executive with "Good Reason", by the Executive's death or by the Executive's "Disability", all stock options so granted will immediately vest and become exercisable. The stock option grants will otherwise be subject to the terms of the stock option plan of Holding.
The Executive will be eligible to participate in employee benefit plans made available to other senior executives of Swiss Re which shall be, in the aggregate, substantially comparable to the plans (other than the Long-Term Incentive Plan and stock option plans) in which the Executive participated immediately prior to December 1, 1998. The Executive will be entitled to perquisites and fringe benefits at least equal to those to which he was entitled on July 27, 1998.
If the Executive's employment is terminated during the Term by Swiss Re without "Cause", by the Executive with "Good Reason", by the Executive's death or by the Executive's "Disability", Swiss Re will pay the Executive: (i) with respect to any complete calendar year remaining in the Term, an amount equal to 50% of the Special Bonus that was or would have been payable upon attainment of 100% of the Management Target for 1999 (the "Termination Bonus Payment"); (ii) with respect to a calendar year in which termination occurs before July 1, an amount equal to the Termination Bonus Payment; or (iii) with respect to a calendar year in which termination occurs after July 1, an amount equal to the sum of (x) a pro rata portion of the Special Bonus (based on actual attainment relative to the Management Target during the entirety of such year) for the period from January 1 through the date of termination, and (y) a pro rata portion of the Termination Bonus for the period from the date of termination through December 31. Swiss Re will pay reasonable attorney's fees and expenses and court costs incurred by the Executive as a result of Swiss Re's failure to perform any provision of the 1998 Agreements.
If the Executive's employment is terminated by death, Swiss Re will pay health insurance benefits for all the Executive's dependents for one year.
If any payments or distributions to the Executive (whether pursuant to the 1998 Agreement or otherwise) are subject to the Excise Tax, Swiss Re will pay the Executive an additional payment so that the net amount retained by the Executive, after deduction of the Excise Tax and all income taxes and Excise Tax on such additional payment, will be the same as if the Excise Tax had not been imposed.
If Swiss Re defaults on its obligation to pay certain amounts to the Executive (and fails to cure the default within thirty days after notice), Swiss Re is required to pay the Executive a lump sum amount actuarially equivalent to future payments otherwise payable under the 1998 Agreements, as well as all past due payments. Swiss Re indemnifies the Executive to the full extent permitted by law for amounts connected with any action relating to performance of the Executive's services. Swiss Re will maintain a directors' and officers' liability insurance policy, using its best efforts to provide substantially similar protection to the protection provided by the policy in effect on July 27, 1998.
The Executive agrees that he will not disclose confidential information or trade secrets of Swiss Re at any time and that, during the Term and for a period of one year thereafter, he will not engage in competition with Swiss Re in the business of reinsuring life insurance risks or solicit any Swiss Re employee to leave such employment.
Any controversy related to the 1998 Agreements will be settled by binding arbitration in Stamford, Connecticut.
ITEM 12
ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
As of March 30, 1999, no director or executive officer of the Company owned any Common Shares.
ITEM 13
ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
INDEBTEDNESS OF MANAGEMENT
During 1992, the Company issued, subject to restricted stock purchase agreements, 214,510 Common Shares to certain officers of the Company and its subsidiaries in exchange for notes in favor of the Company. Certain of the sales were at prices below fair value at the date of sale, resulting in compensation expense to the Company in 1992. Listed in the chart below is the aggregate of the only two remaining loans to an executive officer of the Company to purchase Common Shares that aggregated in excess of $60,000, including accrued interest, during 1998. The loans were fully satisfied in December 1998.
PART IV
ITEM 14
ITEM 14 EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed or incorporated by reference as part of this Form 10-K:
1. Financial Statements
The audited consolidated financial statements of Life Re and the related auditor's report listed in the Index to Financial Statements and Financial Statement Schedule appearing on page 23.
2. Financial Statement Schedule
The schedule listed in the Index to Financial Statements and Financial Statement Schedule appearing on page 46.
3. Exhibits
The accompanying Exhibit Index appearing on page 65 is incorporated herein by reference. The exhibits listed in the Exhibit Index are filed or incorporated by reference as part of this Form 10-K.
(b) No reports on Form 8-K were filed with the Securities and Exchange Commission during the three months ended December 31, 1998.
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.
LIFE RE CORPORATION
By: /s/ JACQUES E. DUBOIS ------------------------------------ Jacques E. Dubois Chairman of the Board, Chief Executive Officer and Director
March 30, 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.
LIFE RE CORPORATION
EXHIBIT INDEX