ITEM 1 - BUSINESS
Safe Harbor Statement
This is a Safe Harbor statement under the Private Securities Litigation Reform Act of 1995. Certain statements contained herein are forward-looking statements that involve risks and uncertainties. Forward-looking statements may be identified by the use of terms such as believes, expects, estimate, may, intends, plan, will, should or anticipates or the negative thereof or similar expressions, or by discussions of strategy. The Company has based the forward- looking statements on current expectations and projections about future events. These forward-looking statements are subject to risks, uncertainties and assumptions about the Company, including: (i) uncertainties and changes in government policy, regulatory policy, statutory law or case law with respect to the Company, brokers or customers which can impede the Company's ability to charge adequate rates and efficiently allocate capital; (ii) the occurrence of man-made or natural catastrophic events; (iii) the occurrence of significant changes in products or adverse changes in market conditions; (iv) changing legal or social trends and the inherent uncertainties of the reserving process, including potential underwriting exposure to Year 2000 claims; (v) loss of the services of any of the Company's executive officers; (vi) initiatives underway at the Company to reorganize business units and to evaluate reinsurance programs and exposures that could lead to additional charges and expense; (vii) that the Company will make steady progress towards underwriting profitability; (viii) the impact of United States tax laws on the Company; (ix) changes in inflation rates and other economic conditions; (x) losses due to foreign currency exchange rate fluctuations; (xi) ability to collect reinsurance recoverables; (xii) changes in the availability, cost or quality of reinsurance; (xiii) developments in domestic and international financial markets that could affect the Company's investment portfolios; (xiv) changes in the distribution or placement of risks due to increased consolidation of insurance and reinsurance brokers; and (xv) the effects of mergers, acquisitions and divestitures.
The Company undertakes no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise. In the light of these risks, uncertainties and assumptions, the forward-looking events discussed herein might not occur. Readers are cautioned not to place undue reliance on any forward-looking statements, which speak only as at their dates.
Overview of the Company
All references to the "Company" are to Terra Nova (Bermuda) Holdings Ltd. and all of its direct and indirect subsidiaries, including Markel International Limited ("Markel International"), Terra Nova Insurance Company Limited ("Terra Nova"), Terra Nova (Bermuda) Insurance Company Ltd. ("Terra Nova (Bermuda)"), Compagnie de Reassurance d'Ile de France ("Corifrance"), Markel Syndicate Management Limited ("Markel Syndicate Management") and Markel Capital Limited ("Markel Capital"). On April 20, 2000, Markel International changed its name from Terra Nova Insurance (UK) Holdings plc, Markel Syndicate Management changed its name from Octavian Syndicate Management Limited and Markel Capital changed its name from Terra Nova Capital Limited. On November 3, 2000, Markel International was re-registered as a private limited company. Accordingly, the name was changed to Markel International Limited and the status of the company changed to private with effect from that date.
On March 24, 2000, the Company was acquired by Markel Corporation ("Markel") for total consideration of approximately $658 million. Markel issued approximately 1.75 million common shares and contingent value rights and paid approximately $325 million in cash to the Company's shareholders in the transaction. The Company's $175 million of debt remained outstanding.
Terra Nova
Terra Nova is authorized in the United Kingdom to transact all classes of insurance business and underwrites business on both a direct and reinsurance basis covering property, casualty, accident and health and marine risks. Terra Nova's business is written internationally with approximately 55% of its writings coming from the United States. In addition Terra Nova writes excess and surplus lines property and automobile physical damages coverages in the United States. Coverage is also provided for crop, boiler and machinery, credit, surety, political risks exposure, theft, fidelity and crime as well as other miscellaneous lines such as contingency.
Property treaty reinsurance includes excess of loss, stop loss, aggregate excess and proportional coverage. A significant proportion of Terra Nova's excess of loss catastrophe and per risk treaty business comes from the United States and loss exposure is balanced by widely spread international property treaties.
Terra Nova's casualty account includes treaty reinsurance for errors and omissions, directors and officers, medical malpractice and general liability risks as well as excess and surplus lines liability coverages often written in conjunction with property risks. Professional groups covered include architects, engineers, accountants, lawyers and insurance intermediaries.
Terra Nova is approved to underwrite excess and surplus lines insurance in almost every state of the United States and has also gained accreditation in various states under statutes providing for accreditation of non-U.S. reinsurers. As at March 30, 2001, Terra Nova was accredited as a reinsurer in forty-five jurisdictions of the United States and had an application for approval pending in a further three. Terra Nova is also licensed to transact non-marine reinsurance in Canada through its branch office in Toronto. During 2000, Terra Nova closed its branch office in Brussels.
Marine insurance is transacted both on a direct and a reinsurance basis and includes cargo, specie, protection and indemnity ("P&I") and liability.
Markel Capital
Through Markel Capital, the Company participates in the Lloyd's syndicates managed by Markel Syndicate Management. For the 2000 underwriting year, Markel Syndicate Management managed six syndicates and had $509.2 million aggregate underwriting capacity net of commission, of which $453.5 million or 89% was provided through Markel Capital. For the 2001 underwriting year, Markel Syndicate Management manages four syndicates with $405.0 million of capacity all of which is provided through Markel Capital.
The Markel Syndicate Management syndicates for the 2000 underwriting year were as follows:
Syndicate 959 ceased writing new business by the end of 1999 and was merged into Syndicate 1009 for the 2000 underwriting year. Syndicate 1227 ceased writing new business by the end of 2000 and was merged into Syndicate 1239 for the 2001 underwriting year. Syndicate 554 ceased writing new business during 1999 and Syndicate 329 ceased writing new business during 2000.
Terra Nova (Bermuda)
Terra Nova (Bermuda) ceased accepting new business on April 2, 2000. The decision follows completion of the Company's acquisition by Markel Corporation and reflects a detailed review of all the Company's entities and their strategic importance within the enlarged Markel Group.
Corifrance
Corifrance is a French reinsurance company based in Paris. Corifrance transacts specialty treaty and facultative reinsurance business internationally, mainly outside the U.S., on a direct and brokered basis. Corifrance is included in Other as part of the segmental reporting as it is a non-strategic insurance subsidiary.
Business Segments
As noted above, on March 24, 2000, the Company was acquired by Markel. As a result, Markel realigned its operations with the Company becoming its international division.
The Company's operating segments have been changed in accordance with this realignment. The Company now includes three operating segments: the London Company Market, the Lloyd's Market and Investing. All investing activities are included in the Investing operating segment. Discontinued programs and non- strategic insurance subsidiaries are included in Other for purposes of segment reporting. Prior year amounts are restated to conform with 2000 presentations.
The London Company Market consists of the operations of Terra Nova, the Lloyd's Market includes Markel Capital, which is the corporate capital provider for six Lloyd's syndicates for the 2000 year of account managed by Markel Syndicate Management. Of the six syndicates, non-marine Syndicate 702, marine Syndicate 1009, motor Syndicate 1228 and non-marine Syndicate 1239 are included in the Lloyd's Market segment while marine Syndicate 329 and non-marine Syndicate 1227 are included in Other as they are discontinued lines of business.
The Company's mix of business by business segment is set out in the table below.
Year ended December 31, --------------------------- --------------------------- Gross written premiums Amount % of total (dollars in millions) London Company Market $180.7 25.6 Lloyd's Market 397.7 56.4 Other 127.0 18.0 ------ --------- Total $705.4 100.0 ------ ---------
Direct business 540.0 76.6 Reinsurance assumed 165.4 23.4 ------ --------- Total for the Company $705.4 100.0 ====== =========
Loss and Loss Adjustment Expense Reserves
General
The loss and loss adjustment expense ("LAE") liabilities consist of case reserves and incurred but not reported ("IBNR") reserves. Case reserves are estimates of future loss payments for insured events which have been reported to the insurer. These reports may be made formally by the cedent or informally by other means, such as evaluation of claims by attorneys. The Company determines case reserves on a contract by contract basis. The amount reserved is the amount expected to be paid and is not discounted or otherwise adjusted for the time value of money. IBNR reserves are established actuarially. They reflect an estimated ultimate loss amount for claims not yet notified and an estimate of possible changes in the value of those claims which have already been reported. The method of setting IBNR reserves depends on the class of business involved. The specific techniques involve the use of projections and models based on the Company's or the relevant market's experience and exposure.
Management believes the Company's reserves for losses and LAE are adequate. However, there can be no assurances that the Company's ultimate losses and LAE will not deviate, perhaps substantially, from the estimates reflected in its financial statements. If the Company's reserves should prove to be inadequate, the Company will be required to increase reserves. This could have a material adverse effect on the Company's financial condition.
The following table shows the development of net reserves for losses and LAE for the calendar years 1990 to 2000 for all lines of business, except the Company's aviation business in run-off. The first line of the table presents the net liabilities, including IBNR, as recorded in the Company's balance sheet for the indicated year and all unpaid losses for prior years. The upper portion of the table shows the liability re-estimated at the end of each of the succeeding years. The conditions that have caused the deficiencies are referred to below and may not be indicative of future developments.
The re-estimated liabilities are increased or decreased as more information becomes available about the severity and frequency of claims for individual years. An adjustment to the carrying value of unpaid claims for a prior year will also be reflected in the adjustments for later years. For example, an adjustment to 1990 loss reserves in 1992 will show in the re-estimation of reserves for the years 1990 through 1991. A redundancy (or deficiency) arises when the re-estimation of reserves at the end of the year is less (or more) than the estimate at the preceding year-end. The redundancy (or deficiency) is recorded in the income statement of that year. The cumulative redundancy (or deficiency) is the difference between the re-estimation of reserves as at the end of 2000 and the original estimate as shown on the top line of the table. The lower portion of the table shows the cumulative amounts paid at the end of each successive year for such claims.
The following table represents an analysis of gross loss and LAE reserve development for the years indicated:
(1) "Reserves re-estimated" includes losses paid in current and prior years.
(2) "Reinsurance recoveries on unpaid losses" includes reinsurance recoveries received in current and prior years.
The adverse prior year development of $44.9 million is largely attributable to inadequate pricing on the discontinued lines and portions of the continuing programs for the 1997, 1998 and 1999 accident years. These deficiencies have been partially offset by net favorable development experienced on the 1986 to 1990 accident years. This net favorable development arises on the Company's casualty accounts offset by deterioration on the asbestos related and environmental pollution losses in both the marine and casualty accounts on the 1985 and prior accident years.
Regulation of the Company
The Company's insurance subsidiaries are subject to regulation and supervision by the insurance regulatory authorities of the various jurisdictions in which they conduct business. Regulation is intended for the benefit of policyholders rather than shareholders. For information regarding the Company's ability to receive dividends from its subsidiaries and for information about pledged assets, see Note 17 and Note 4, respectively, to the consolidated financial statements.
Investments
The Company's business philosophy clearly recognizes the importance of both underwriting profits and superior investment returns to build shareholder value. The Company relies on sound underwriting practices to produce investable funds while minimizing underwriting risk. Approximately three quarters of the Company's investable assets come from premiums paid by policyholders. Policyholder funds are invested predominantly in high-quality corporate, government and municipal bonds with relatively short durations. The balance, comprised of shareholder funds, is available to be invested in equity securities, which over the long run, have produced higher returns relative to fixed income investments. The Company seeks to invest in companies with the potential for appreciation and hold these investments over the long term. Officers of the Company manage the investment portfolio.
ITEM 2
ITEM 2 - PROPERTIES
For information regarding the Company's future minimum property lease commitments see Note 13 to the consolidated financial statements.
ITEM 3
ITEM 3 - LEGAL PROCEEDINGS
See Note 13 to the consolidated financial statements for a description of legal proceedings.
PART II
ITEM 5
ITEM 5 - MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
On March 24, 2000, all of the Company's shares were acquired by Markel Corporation. There is no established public trading market for the Company's common shares.
During 2000, the Company paid a $75 million dividend to Markel.
ITEM 7
ITEM 7 - MANAGEMENT'S NARRATIVE ANALYSIS OF RESULTS OF OPERATIONS
Business Operations
The following discussion addresses the principal factors affecting the operations of the Company.
On March 24, 2000, the Company was acquired by Markel. As a result, Markel realigned its operations with the Company becoming its international division. The Company's operating segments have been changed in accordance with this realignment. The Company now includes three operating segments: the London Company Market, the Lloyd's Market and Investing. All investing activities are included in the Investing operating segment. Discontinued programs and non- strategic insurance subsidiaries are included in Other for purposes of segment reporting. Prior year amounts have been restated to conform with 2000 presentations.
The Company's premiums by segment for the years ended December 31, 2000 and 1999, and the combined ratio are set out in the following table:
Year ended December 31, -------------------------------------------- 2000 1999 Amount Percent Amount Percent (dollars in thousands) -------------------------------------------- Gross written premiums London Company Market $180,709 25.6% $246,219 28.5% Lloyd's Market 397,738 56.4 260,082 30.1 Other 126,958 18.0 358,632 41.4 -------- ------ -------- ------ Total $705,405 100.0% $864,933 100.0% ======== ====== ======== ====== Net written premiums London Company Market $150,213 27.6% $179,563 29.0% Lloyd's Market 310,597 57.0 188,750 30.5 Other 84,084 15.4 250,133 40.5 -------- ------ -------- ------ Total $544,894 100.0% $618,446 100.0% ======== ====== ======== ======
Net earned premiums London Company Market $186,655 30.9% $227,694 38.9% Lloyd's Market 248,213 41.1 141,022 24.1 Other 168,671 28.0 216,565 37.0 -------- ------ -------- ------ Total $603,539 100.0% $585,281 100.0% ======== ====== ======== ======
Combined ratio Loss ratio (including LAE) 91.5% 83.9% Expense ratio 42.3 46.3 ------ ------ Combined ratio 133.8% 130.2% ====== ======
Results of Operations
Year Ended December 31, 2000 Compared to Year Ended December 31, 1999
Gross written premiums decreased 18.4% to $705.4 million in 2000 from $864.9 million in 1999. The decreases are primarily a result of:
(a) 26.6% decrease in gross written premiums at the London Company Market to $180.7 million in 2000 from $246.2 million in 1999. The decrease was predominantly the result of Terra Nova reducing its property writings on the property pro rata business by 68.4% to $13.5 million in 2000 from $42.7 million in 1999 as a consequence of a detailed review of poor performing accounts. In addition, Terra Nova reduced writings on marine and casualty lines to increase its focus on underwriting profitability.
(b) Significant decreases in gross written premiums in discontinued lines due to the closure of motor Syndicate 554 in the second half of 1999, the closure of Terra Nova (Bermuda) on April 2, 2000, and the decision to cease underwriting at marine Syndicate 329 and non marine Syndicate 1227, and the cessation of certain unprofitable lines at motor Syndicate 1228 in the third quarter of 2000.
(c) These decreases have been partially offset by a 52.9% increase in gross written premiums at the Lloyd's Market in 2000. The increase is primarily due to Markel Capital increasing its participation on the continuing syndicates to approximately 87% in 2000 compared to approximately 68% in 1999 and increased writings at non marine Syndicate 702 and marine and aviation Syndicate 1009. The increased writings at non marine Syndicate 702 primarily arose on certain professional indemnity classes. The increased writings at marine and aviation Syndicate 1009 are a consequence of the syndicate writing $41.1 million of aviation business in 2000.
In 1999, aviation business was written by aviation Syndicate 959 which was merged into Syndicate 1009 for 2000.
Net written premiums decreased 11.9% to $544.9 million in 2000 from $618.4 million in 1999 principally in line with the fall in gross written premiums. This fall was offset by an increase in retention rates to 77.2% in 2000 from 71.5% in 1999. The low retention rate in 1999 was primarily due to the purchase of additional reinsurance at the end of 1999 to protect against exposure to aviation and satellite business written by Syndicate 959.
Net earned premiums remained broadly unchanged in 2000, increasing by 3.1% to $603.5 million from $585.3 million in 1999. This arose because the decrease in 2000 net written premiums was offset by 1999 premiums being earned during the year.
The underwriting loss increased to $203.8 million in 2000 from $176.8 million in 1999. The underwriting loss in 2000 was primarily the result of inadequate pricing and poor underwriting controls on the discontinued lines and portions of the continuing programs. The increased underwriting loss reflects non-recurring transaction related expenses of $58.6 million in the first quarter and $145.2 million of underwriting losses from operations.
Charges which are expected to be non-recurring include:
(a) $36.5 million charge against deferred acquisition costs due to poor experience on property business and certain marine, casualty and auto lines.
(b) $19.6 million of reserve strengthening required on marine, property, casualty and auto accounts.
(c) A $2.5 million charge to record liabilities under an operating lease.
The $145.2 million underwriting loss from operations was due to poor performance on both continuing and discontinued lines of business including the cessation of business at Terra Nova (Bermuda), Syndicates 329 and 1227 and certain lines at 1228, and the adoption of the Markel reserving philosophy.
The Company is currently working to increase its focus on underwriting profitability in continuing programs. A run-off unit has been established to aggressively manage discontinued programs and allow the business units to focus on writing profitable business. These initiatives may lead to further re-pricing or discontinuance of poor performing lines of business, reorganisation of business units to achieve operating efficiencies and the review of reinsurance programs.
As a consequence of the above, the Company's combined ratio increased to 133.8% in 2000, compared to 130.2% in 1999.
The Company had a pre-tax loss of $144.7 million in 2000 compared to pre- tax loss of $72.6 million in 1999, and was primarily a result of the $203.8 million underwriting loss and merger expenses of $18.4 million being partially offset by $84.9 million and $8.7 million of investment income and realized investment gains, respectively.
The post-tax loss was $132.3 million in 2000 compared to a post-tax loss of $35.0 million in 1999.
Shareholder's equity decreased by 37.2% to $278.7 million at December 31, 2000, compared to $444.0 million at December 31, 1999. The decrease of $156.3 million was primarily due to the net loss of $132.3 million and a $75.0 million dividend paid to Markel Corporation on March 28, 2000, partially offset by unrealized appreciation of investments after tax of $33.1 million and other comprehensive loss and deferred equity compensation movements of $17.9 million.
ITEM 7A
ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Market risk is the risk of economic losses due to adverse changes in the estimated fair value of a financial instrument as a result of changes in equity prices, interest rates, foreign exchange rates and commodity prices. The Company's consolidated balance sheets include assets and liabilities whose estimated fair values are subject to market risk. The primary market risks to the Company are equity price risk associated with investments in equity
securities, interest rate risk associated with investments in fixed maturities and foreign exchange risk. The Company has no material commodity risk.
Equity Price Risk
The Company does not ordinarily hedge its equity portfolio risk by purchasing derivatives. In March 2000, the Company transferred the responsibility for monitoring its equity portfolio to Markel Gayner Asset Management, a subsidiary of Markel. This responsibility involves considering the asset allocation of the portfolio in order to minimize the risk associated with particular markets or industry sectors, while continuing to follow the Company's long-term objective of growing its book value.
At December 31, 2000, the cost of the Company's equity security portfolio was $70.8 million and the fair value was $87.1 million, compared to $98.3 million and $109.9 million, respectively, at December 31, 1999.
Interest Rate Risk
The Company's major market risk exposure is changing interest rates, primarily in the United States. A change in interest rates would affect the fair value of the Company's investments and could cause fluctuations in Accumulated Other Comprehensive Income in the balance sheet. The Company manages this risk by limiting the portfolio duration.
The matrix above shows the sensitivity of the Company's shareholder's equity at December 31, 2000, and December 31, 1999, to movements in fixed maturity valuations related to changes in interest rates. The aggregate hypothetical reduction in net assets that would have resulted from a hypothetical increase in yield of 100 basis points at December 31, 2000, is $35.1 million. As a consequence, shareholder's equity at December 31, 2000, would have been $243.6 million and the ratio of debt to debt plus equity would have increased to 41.8% from 38.6%.
The Company's long-term debt is all at fixed rates. At December 31, 2000, and December 31, 1999, the Company's total outstanding indebtedness was $175 million, comprised of $75 million 7.2% Senior Notes due 2007 and $100 million 7.0% Senior Notes due 2008. The estimated fair value of the debt at December 31, 2000, and December 31, 1999, was $161.2 million and $162.8 million, respectively.
Foreign Exchange Risk
The Company has foreign exchange risk on assets and liabilities. The Company primarily manages this risk by matching assets to liabilities in each foreign currency as closely as possible.
At December 31, 2000, 66% of the Company's investment portfolio was denominated in U.S. Dollars. At that date the largest foreign currency exposure was U.K. Sterling. If Sterling assets and liabilities had been mismatched by 10% at December 31, 2000, and the year end Sterling/U.S. Dollar exchange rate had increased or decreased by 5%, the effect on after tax earnings would have been approximately $1.3 million.
Impact of Inflation
Property and casualty insurance premiums are established before the amount of losses and loss adjustment expenses, or the extent to which inflation may affect such expenses, is known. Consequently, in establishing premiums, the Company attempts to anticipate the potential impact of inflation. Inflation is also considered by the Company in the determination and review of reserves for losses and loss adjustment expenses since portions of these reserves are expected to be paid over extended periods of time. The importance of continually reviewing reserves is even more pronounced in periods of extreme inflation.
Impact of Accounting Standards
Financial Accounting Standards Board Statement of Financial Accounting Standards (SFAS) No. 133, Accounting For Derivative Instruments and Hedging Activities, as amended by SFAS No. 137 and 138, is effective for years beginning January 1, 2001. The standard requires that all the derivatives be recorded as an asset or liability, at estimated fair value, regardless of the purpose or intent for holding the derivative. If a derivative is not utilized as a hedge, all gains or losses from the change in the derivative's estimated fair value are recognized in earnings. The gains or losses from the change in estimated fair value of certain derivatives utilized as hedges are recognized in earnings or other comprehensive income depending on the type of hedge relationship. Due to the Company's limited use of derivative financial instruments, the adoption of SFAS No. 133, as amended, will not have a material impact on the Company's financial position, result of operations or cash flows.
ITEM 8
ITEM 8 - FINANCIAL STATEMENTS
REPORT OF INDEPENDENT ACCOUNTANTS (KPMG Audit Plc)
To the Shareholder and Board of Directors of Terra Nova (Bermuda) Holdings Ltd.
We have audited the accompanying consolidated balance sheet of Terra Nova (Bermuda) Holdings, Ltd. and subsidiaries (the Company) as of December 31, 2000, and the related consolidated statements of operations, comprehensive (loss) income, shareholder's equity and cash flows for the year then ended. In connection with our audit of the consolidated financial statements, we have also audited the 2000 financial statement schedules appearing under Item 14(a). These consolidated financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audit.
We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the 2000 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Terra Nova (Bermuda) Holdings, Ltd. and subsidiaries as of December 31, 2000, and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related 2000 financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
KPMG Audit Plc
London, United Kingdom March 30, 2001
REPORT OF INDEPENDENT ACCOUNTANTS (PricewaterhouseCoopers)
To the Shareholders and Board of Directors of Terra Nova (Bermuda) Holdings Ltd.
In our opinion, the consolidated financial statements for the years ended December 31, 1999 and December 31, 1998 included on page 12 present fairly, in all material respects, the financial position of Terra Nova (Bermuda) Holdings Ltd. and subsidiaries at December 31, 1999, and the result of their operations and their cash flows for each of the two years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the index appearing under Item 14(a) on page 39 present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedules are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. We have not audited the consolidated financial statements or financial statement schedules of Terra Nova (Bermuda) Holdings Ltd. and subsidiaries for any period subsequent to December 31, 1999.
PRICEWATERHOUSECOOPERS Chartered Accountants
Hamilton, Bermuda March 10, 2000
TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES
Consolidated Balance Sheets At December 31, (dollars in thousands)
See accompanying notes to the consolidated financial statements
TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES
Consolidated Statements of Operations Year Ended December 31, (dollars in thousands)
See accompanying notes to the consolidated financial statements
TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES
Consolidated Statements of Comprehensive (Loss) Income Year Ended December 31, (dollars in thousands)
See accompanying notes to the consolidated financial statements
TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES
Consolidated Statements of Shareholder's equity Year Ended December 31,
See accompanying notes to the consolidated financial statements
TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES
Consolidated Statements of Cash Flows Year Ended December 31, (dollars in thousands)
See accompanying notes to the consolidated financial statements
TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES
Notes to Consolidated Financial Statements
1. Organization
Terra Nova (Bermuda) Holdings Ltd. ("Bermuda Holdings") is incorporated in Bermuda. All references to the "Company" are to Terra Nova (Bermuda) Holdings Ltd. and all of its direct and indirect subsidiaries, including Markel International Limited ("Markel International"), Terra Nova Insurance Company Limited ("Terra Nova"), Terra Nova (Bermuda) Insurance Company Ltd. ("Terra Nova (Bermuda)"), Compagnie de Reassurance d'Ile de France ("Corifrance"), Markel Syndicate Management Limited ("Markel Syndicate Management") and Markel Capital Limited ("Markel Capital"). On April 20, 2000, Markel International changed its name from Terra Nova Insurance (UK) Holdings plc, Markel Syndicate Management changed its name from Octavian Syndicate Management Limited and Markel Capital changed its name from Terra Nova Capital Limited. On November 3, 2000, Markel International was re-registered as a private limited company. Accordingly, the name was changed to Markel International Limited and the status of the company changed to private with effect from that date.
On March 24, 2000, the Company was acquired by Markel Corporation ("Markel") for total consideration of approximately $658 million. Markel issued approximately 1.75 million common shares and contingent value rights and paid approximately $325 million in cash to the Company's shareholders in the transaction. The Company's $175 million of public debt remained outstanding.
The Company is a specialty property, casualty, marine and aviation insurance and reinsurance company. It operates in the London Market and the Lloyd's Market through its London based subsidiaries, Terra Nova and Markel Capital. The Company operates in the Continental European market through its French subsidiary, Corifrance. The Company ceased accepting new business through its Bermuda based subsidiary, Terra Nova (Bermuda) in April 2000. Writings originate worldwide. It writes most insurance and reinsurance business through brokers authorized to place business at Lloyd's. It also writes through non-Lloyd's brokers and with individual ceding companies. The broker is generally regarded as the agent of the insured or reinsured in placing the business. The Company also owns the business and assets of Markel Syndicate Management, a Lloyd's managing agent, consisting of the rights to manage certain Lloyd's syndicates (the "Markel Syndicate Management syndicates").
A managing agent is permitted by the Council of Lloyd's to perform, on behalf of an underwriting member of any one of the syndicates which it manages, one or more of the following functions:
a) underwriting contracts of insurance at Lloyd's; b) obtaining reinsurance for such contracts in whole or in part; c) paying claims on such contracts.
Members of Lloyd's underwrite insurance risk at Lloyd's by being a member of one or more Lloyd's syndicates. A syndicate has no separate legal identity and is "managed" by a managing agent.
The standard Lloyd's contract between a managing agent and the members of a syndicate managed by that agent, identifies the following services to be provided by the managing agent on behalf of the members:
a) determine underwriting policy and determine policy and effect reinsurance including the reinsurance to close; b) appoint and supervise the underwriter and associate underwriting, claims, administrative and accounting staff; c) accept underwriting risks and settle and pay claims on behalf of the syndicate; d) manage the investment of the monies and other assets held in each syndicate; e) prepare and distribute annual reports, personal accounts and other reports and documents as required by the Council of Lloyd's.
A managing agent charges an annual fee which will be complimented, in profitable years, by a profit commission. The managing agent employs management and underwriting staff, recharging the costs of employment and resourcing the syndicate's activities to the syndicate and retaining costs incurred in respect of the management functions.
TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES
Notes to Consolidated Financial Statements
The managing agent does not participate directly in the profit or loss on underwriting of its syndicates. It is incentivized by earning a commission on syndicate profits. Markel Syndicate Management will not charge a profit commission from the 2001 underwriting year.
The managing agency manages but does not participate in its own syndicates and has no liability under contracts of insurance. However, Markel Capital, a subsidiary of Markel International, is a corporate member of Lloyd's and a member of each of the syndicates managed by Markel Syndicate Management. Markel Capital therefore participates in the underwriting results of the Markel Syndicate Management syndicates.
2. Basis of Preparation
The accompanying consolidated financial statements have been prepared on the basis of United States generally accepted accounting principles ("GAAP"). All material intercompany transactions and balances have been eliminated.
3. Significant Accounting Policies
(a) Investments and related income: Investments in fixed maturities and equity securities are classified as available for sale and held with the intention of selling such investments from time to time, and are carried at fair value. Unrealized gains and losses, net of related deferred income taxes and minority interests, are recorded in shareholder's equity. Realized gains and losses are included in operations and determined by specific identification. Investment income is recorded as earned.
(b) Cash and cash equivalents: Cash and cash equivalents consist of cash and various short-term investments which have maturities when bought of 90 days or less. Cash equivalents are stated at fair value which approximates cost.
(c) Premiums: Premiums are earned pro-rata over the term of the related coverage. The balance of unearned premiums represents the portion of gross written premiums relating to the unexpired terms of coverage.
(d) Markel Syndicate Management income and expenses: The Company recognizes its share of the premiums, losses and expenses associated with its participation in Lloyd's syndicates consistent with the bases used in its insurance company operations and in accordance with GAAP. Agency income is earned and agency expenses charged as incurred from Markel Syndicate Management's role as managing agent.
(e) Deferred acquisition costs: Acquisition costs, which represent net commission and other expenses incurred in producing business, are deferred and amortized over the period in which the related premiums are earned. If it is determined that future policy revenues on existing policies are not adequate to cover related costs and expenses, deferred policy acquisition costs are charged to earnings.
(f) Insurance balances receivable and reinsurance recoverable on paid and unpaid losses: Receivable balances are stated net of allowances for doubtful accounts. Reinsurance recoverable on unpaid losses represents the estimated portion of such liabilities that will be recovered from reinsurers, determined in a manner consistent with the related liabilities.
(g) Income taxes: Deferred income taxes are recorded on temporary differences between financial reporting and tax bases of assets and liabilities in accordance with Statement of Financial Accounting Standard ("SFAS") No. 109.
TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES
Notes to Consolidated Financial Statements
(h) Foreign currency translation: The U.S. dollar is the reporting currency and principal functional currency, as most of the policies written are denominated in U.S. dollars. Revenues and expenses in non-U.S. dollar currencies are translated at the average rates of exchange. Monetary assets and liabilities are translated at the rate of exchange in effect at the close of the period. Non-monetary assets and liabilities, primarily deferred revenue and expenses, are translated at historical rates of exchange. Gains or losses resulting from non-U.S. dollar transactions are included in net income. Certain other net translation adjustments are shown as a separate item of shareholder's equity.
(i) Accrued premium income: Accrued premium income represents the difference between the estimated cumulative ultimate gross written premiums and cumulative billed premiums.
(j) Prepaid reinsurance premiums: Prepaid reinsurance premiums represent the portion of premiums ceded to reinsurers applicable to the unexpired terms of reinsurance contracts.
(k) Losses and loss adjustment expenses: Losses and loss adjustment expenses are charged to income as incurred. The reserve for unpaid losses and loss adjustment expenses represents estimates for reported losses, including provisions for losses incurred but not reported ("IBNR"). The adequacy of these estimates is assessed by reference to projections of the ultimate losses for each accident year. The methods of determining such estimates and establishing reserves are reviewed continually and updated. Resulting adjustments are reflected in current operations.
(l) Stock-based compensation: The Company has adopted SFAS No.123 "Accounting for Stock-Based Compensation". As allowed under this standard, the Company accounts for stock option grants in accordance with APB Opinion No.25 "Accounting for Stock Issued to Employees".
Compensation expense for stock option grants is recognized to the extent that the fair value of the stock exceeds the exercise price of the option at the measurement date. Any resulting compensation expense is accrued over the shorter of the vesting or service period.
Deferred compensation, recorded as a component of shareholder's equity, represents options the Company expected to be settled in stock.
(m) Risks and uncertainties: The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions. These affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
(n) Fair value of financial instruments: The following methods and assumptions were used by the Company in estimating the fair value of the financial instruments presented:
- Investments: Fair values were based on quoted market prices. For securities for which market prices were not readily available, fair values were estimated using quoted market prices of comparable investments.
- Long term debt: Fair value is based on quoted market price.
- Other financial instruments: The carrying amounts approximate fair value.
(o) Goodwill: The goodwill in the Company's balance sheet has been calculated using the purchase method of accounting and is amortized on a straight line basis over periods not exceeding 40 years.
(p) Reclassifications: Certain prior year amounts have been reclassified to conform with the current year presentation.
TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES
Notes to Consolidated Financial Statements
4. Investments and Cash
(a) Deposits: Securities with a carrying value of $148,939,275 and $122,105,666 at December 31, 2000 and 1999, respectively, were held in trust for the benefit of the Company's U.S. cedents and to facilitate the Company's accreditation as an alien reinsurer by certain States.
Cash and securities with a carrying value of $22,243,365 and $20,994,932 at December 31, 2000 and 1999, respectively, were held in trust for the benefit of the Company's U.S. surplus lines policyholders.
Cash and securities with a carrying value of $50,184,172 and $49,607,415 at December 31, 2000 and 1999, respectively, were held in trust for the benefit of the Company's Canadian cedents.
The Company has contingent liabilities regarding undrawn letters of credit supporting certain reinsurance business written by the Company in the U.S. of $95,984,794 and $97,420,004 at December 31, 2000 and 1999, respectively. The Company has deposited cash and investments with a carrying value of $105,583,273 and $105,812,403 at December 31, 2000 and 1999, respectively, as collateral against these amounts.
The Company has deposits at Lloyd's with a carrying value of $42,909,618 in support of the Company's underwriting activities on the Markel Syndicate Management syndicates. The Company also has contingent liabilities regarding irrevocable undrawn letters of credit of $187,014,278 and $246,886,653 supporting the Company's underwriting activities on the Markel Syndicate Management syndicates at December 31, 2000 and 1999, respectively. The Company has deposited cash and investments with a carrying value of $208,030,000 at December 31, 2000 and $251,527,716 at December 31, 1999, respectively, as collateral to support this commitment. Cash and securities with a carrying value of $303,193,000 and $202,931,000 at December 31, 2000 and 1999, respectively, were held in trust for the benefit of the Markel Syndicate Management syndicates' policyholders.
(b) Net investment income: An analysis of the net investment income of the Company is as follows:
TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(c) Investment gains and losses: The realized net capital gains and changes in net unrealized appreciation or depreciation of investments are summarized below:
Realized net capital gains (losses) on sale of fixed maturities for the years ended December 31, 2000, 1999 and 1998, included gross capital gains of $11,937,000, $5,754,000 and $9,420,000, and gross capital losses of $18,863,000, $11,820,000 and $566,000, respectively.
Proceeds from sales of investments in equity securities during 2000, 1999 and 1998, were $90,299,000, $174,530,000 and $140,564,000, respectively. Realized net capital gains on sale of equity securities for the years ended December 31, 2000, 1999 and 1998, included gross capital gains of $28,122,000, $42,403,000 and $24,567,000 and gross capital losses of $12,490,000, $9,458,000 and $15,458,000, respectively.
Net unrealized appreciation of equities (before income tax) of the Company at December 31, 2000, included gross unrealized appreciation of $14,419,000 and gross unrealized depreciation of $2,346,000. Net unrealized appreciation of equities of the Company at December 31, 1999, included gross unrealized appreciation of $12,894,000 and gross unrealized depreciation of $1,329,000.
(d) Fixed maturities available for sale: At December 31, the amortized cost and estimated fair value of investments in fixed maturities of the Company were as follows:
TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
The amortized cost and estimated fair value of the Company's fixed maturities at December 31, 2000, by contractual maturity date, are shown in the following table. Actual maturities may differ from contractual maturities because borrowers may have the right to call or repay certain obligations with or without call or prepayment penalties.
Mortgage and asset backed securities which are not due at a single maturity date have been allocated according to their expected final payment date as at year end.
(e) At December 31, 2000, the Company's portfolio by rating category, determined by recognized rating agencies, was:
(f) At December 31, 2000, the estimated fair value of the following investments exceeded 10% of shareholder's equity:
TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(g) Equities available for sale: At December 31, 2000, the cost and estimated fair value of investments in common stocks were as follows:
5. Income Taxes
(a) The U.K. corporation tax rate applicable to ordinary income was reduced to 31% from 33% on April 1, 1997, and to 30% from 31% on April 1, 1999. The corporation tax rate in France was 41.67% for 1998, 40% for 1999 and 37.7% for 2000. The difference between the actual tax expense and the "expected" amount calculated by applying the U.K. corporation tax rate is explained as follows:
(b) The components of income tax (benefit) expense attributable to continuing operations are as follows:
(c) Deferred tax liabilities and assets are provided for expected future tax consequences of events that have been recognized in the consolidated financial statements or tax returns. The measurement of current and deferred tax liabilities and assets is based on the difference between the financial statements and tax bases of assets and liabilities using enacted rates in effect for the years in which the differences are expected to reverse. Measurement of a deferred tax asset, if any, is subject to the expectation of future realization. The components of net deferred tax asset (liability) of the Company as at December 31, 2000 and 1999, were as follows:
TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
The valuation allowance of $33.7 million relates primarily to losses at Markel Capital and the uncertainty of realizing a future tax benefit. The Company expects to realize the gross deferred tax asset at December 31, 2000, of $44.2 million through future taxable income generated by its subsidiaries.
(d) Under current Bermuda law, Terra Nova (Bermuda) and Bermuda Holdings are not required to pay any taxes in Bermuda on either income or capital gains. Terra Nova (Bermuda) and Bermuda Holdings have received an undertaking from the Minister of Finance in Bermuda that in the event of any such taxes being imposed, they will be exempted from such taxation until the year 2016.
6. Deferred Acquisition Costs
The following reflects the acquisition costs deferred for amortization against future income and the amortization charged to income, including amounts deferred and amortized in the same period:
TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
7. Employee Benefits
Terra Nova operates a defined benefit pension plan ("Terra Nova Plan") covering all employees (except those in Canada and Belgium) over 20 years old who meet the eligibility conditions set out in the plan document. The cost of providing pensions for employees is charged to earnings over the average working life of employees according to the recommendations of qualified actuaries. Annual funding requirements are determined based on the projected unit credit cost method, which attributes a pro rata portion of the total projected benefit payable at normal retirement to each year of credited service. Final benefits are based on the employee's years of credited service and the higher of pensionable compensation received in the calendar year preceding retirement or the best average pensionable compensation received in any three consecutive years in the ten years preceding retirement.
Mandatory employee contributions to the Terra Nova Plan ceased in 1988. There are no present plans to reintroduce such contributions. Employees may elect to make voluntary contributions to supplement their pension benefits when payable.
Terra Nova provides pension and related benefits for the employees of its branch office in Canada and its former branch office in Belgium. Benefit plans are in line with local market terms and conditions of employment and are generally costed to be within 10% of basic salaries of the participating employees. Neither of the plans is a defined benefit plan. The Company had historically adopted for its Bermuda employees, a similar policy on pension and related benefits and provided for a plan on the same cost basis. Since May 2000, the Company has no Bermuda employees.
Terra Nova maintains a supplemental pension plan which provides pension benefits for nominated employees above amounts allowed under tax qualified plans, through a funded money purchase plan.
Markel Syndicate Management provides certain of its employees with one of two defined benefit pension schemes run in conjunction with the Lloyd's Superannuation Scheme ("Markel Syndicate Management Plans"). The Markel Syndicate Management Plans are similar in operation to the Terra Nova Plan though the benefit structure differs.
Markel Syndicate Management provides a defined contribution plan for nominated employees and directors. The annual contribution rate for employees is 15% of annual pensionable salary and, for directors and certain senior underwriters, is 25% of annual pensionable salary.
Corifrance provides two defined contribution plans for its managers and all other employees. The annual contribution rate for managers is 5.66% of pensionable salary and, for employees, is 1.43% of pensionable salary.
The total cost of the Company's defined contribution plans for the year was $3,035,586 (1999: $3,121,304).
The following tables set out the funded status of all defined benefit plans for the years ended December 31, 2000, 1999 and 1998, and the amounts recognized in the accompanying consolidated balance sheets of the Company at December 31, 2000 and 1999:
TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
8. Share Capital
At December 31, 1999, the Company had 75,000,000 "A" ordinary shares (par value $5.80) of which 24,348,192 were issued and outstanding, and 10,000,000 "B" ordinary shares (par value $5.80) of which 1,796,217 were issued and outstanding.
On March 24, 2000, Markel owned 2,069 shares. On the same date the remainder of the existing "A" and "B" shares were cancelled and replaced by a new issue of 40,000,000 "A" shares (par value $5.80) to Markel.
The "A" ordinary shares and "B" ordinary shares rank pari passu in right to receive dividends. Each "B" ordinary share at the Company is convertible at the choice of the holder into an "A" ordinary share without payment or adjustment for accrued dividends.
9. Share Options and Awards
At December 31, 1999, the Company had two stock-based compensation plans. The Terra Nova Approved and Non Approved Executive Share Option Scheme provided for the grant to eligible employees of options to buy Class A ordinary shares of the Company. The Octavian Stock Option Plan provides for the grant of options to former and current members of management of Octavian (now Markel Syndicate Management) based on profit commissions receivable by Markel Syndicate Management for the 1997 to 2000 years of account.
On acquisition by Markel each outstanding option under the Terra Nova Approved and Non Approved Executive Share Option Scheme and, if issued before January 1, 2000, each outstanding option under the Octavian Plan was treated as fully exercised and converted into the right to receive the consideration payable in the transaction.
TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
The Octavian Plan is a variable plan for accounting purposes. The accounting follows paragraphs 27 and 28 of APB Opinion No.25. Compensation expense of $212,000 has been charged against income in the period from January 1, 2000, to the date of the Markel acquisition (full year charge 1999: $2,941,000). The Octavian Plan was amended to provide for the issuance of options to purchase Markel common stock.
10. Reinsurance
In the ordinary course of business, the Company cedes reinsurance to other insurance companies. Ceded reinsurance arrangements provide greater diversification of business and limit the net loss potential arising from large risks. Certain of these arrangements consist of excess of loss contracts which protect against losses over stipulated amounts. Reinsurance is effected under reinsurance treaties and by negotiation on individual risks.
The current reinsurance protections mainly consist of non-proportional excess of loss reinsurance with the balance being proportional and facultative reinsurance. Specific excess of loss reinsurance is purchased for marine and aviation and non-marine business. Availability of reinsurance at reasonable cost and under favorable terms is one of the key determinants in the decision about which categories of business to emphasize at any given time.
A credit risk exists with reinsurance ceded to the extent that any reinsurer is unable to meet the obligations assumed under the reinsurance arrangements. As is customary in the London Market, collateral is not generally obtained from reinsurers. Reinsurance contracts do not relieve the ceding company from its obligations to policyholders. Failure of reinsurers to honor their obligations could result in losses; so allowances are established for amounts thought uncollectable. The Company evaluates the financial condition of its reinsurers and monitors concentrations of credit risk arising from its exposure to individual reinsurers.
The Company cedes reinsurance to and assumes reinsurance from Lloyd's syndicates. At December 31, 2000, the aggregate exposure in respect of reinsurance ceded to Lloyd's syndicates in respect of continuing operations, including estimated reinsurance recoveries for losses incurred but not reported, was $183.7 million. The majority was ceded into Equitas with effect from September 4, 1996. Equitas is a reinsurance company that was formed to reinsure the 1992 and prior losses of Lloyd's syndicates. Therefore, ultimate recoveries under the reinsurance contracts ceded into Equitas will be dependent on Equitas being able to fulfil its commitment to the syndicates. No specific bad debt provision has been established for amounts due from Equitas and Lloyd's syndicates.
On January 29, 2001, Reliance Insurance Company entered into an order of supervision with the Pennsylvania Insurance Department under which its business and operations will be monitored and reviewed by the Department. At December 31, 2000, Reliance Insurance Company and its affiliates (Reliance Insurance Group) owed the Company approximately $33.4 million in reinsurance recoverables for paid and unpaid losses. These balances were considered in the normal course of assessing the collectability of reinsurance recoverables. The Company believes this matter will not have a material impact on its financial condition or result of operations.
In the years ended December 31, 2000, 1999 and 1998, the percentage of reinsurance premiums assumed to net written premiums was 30.4%, 42.6% and 54.4%, respectively.
(a) Net written premiums are comprised of the following:
TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(b) Net earned premiums are comprised of the following:
(c) Losses and loss adjustment expenses, net, are comprised of the following:
11. Unpaid Losses and Loss Adjustment Expenses
Management believes that its reserves for losses and loss adjustment expenses are adequate. Significant delays occur in notifying certain claims and a large measure of experience and judgment is involved in assessing outstanding liabilities, the ultimate cost of which cannot be known with certainty at the balance sheet date. The reserve for unpaid losses and loss adjustment expenses is determined on the basis of information currently available. However, it is inherent in the nature of the business written that the ultimate liabilities may vary as a result of subsequent development.
Movement in unpaid losses and loss adjustment expenses for the years ended December 31, 2000, 1999 and 1998, is summarized in the table below.
TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
The adverse prior year development of $44.9 million during 2000 is largely attributable to inadequate pricing on the discontinued lines and portions of the continuing programs for the 1997, 1998 and 1999 accident years. These deficiencies have been partially offset by net favorable development experienced on the 1986 to 1990 accident years. This net favorable development arises on the Company's casualty accounts offset by deterioration on the asbestos-related and environmental pollution losses in both the marine and casualty accounts on the 1985 and prior accident years.
Management has considered environmental and latent injury claims and claims expenses in establishing the Company's reserve for unpaid losses and loss adjustment expenses. The Company continues to be advised of claims asserting injuries from hazardous materials and alleged damages to cover various clean-up costs affecting policies written in prior years. Coverage and claim settlement issues, such as determining that coverage exists and defining an occurrence, may cause the actual loss development to show more variation than the rest of the Company's book of business. Traditional reserving techniques cannot be used to estimate asbestos-related and environmental pollution claims and so the uncertainty about the ultimate cost of these types of claims is greater than the uncertainty relating to standard lines of business. The Company believes it has made reasonable provisions for claims, although the ultimate liability may be more or less than held reserves. The Company believes that future losses associated with these claims will not have a material adverse effect on its financial position. Still, there is no assurance that such losses will not materially affect the Company's results of operations for any period. Management is not able to estimate the additional loss, or range of loss, that is reasonably possible.
TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
The following table presents selected data on asbestos-related and environmental pollution losses and loss adjustment expenses incurred and reserves outstanding, net of amounts recoverable from reinsurers:
Asbestos-related and Environmental Losses and Loss Adjustment Expenses Incurred and Reserves Outstanding (net of reinsurance)
The reinsurance recoverables netted against the asbestos-related and environmental pollution loss reserves for each of the years 2000, 1999 and 1998, are as follows:
12. Allowance for Doubtful Accounts
Insurance balances receivable and reinsurance recoverable on paid and unpaid losses are stated after deduction of an allowance for doubtful accounts at December 31, 2000 and 1999, of $48,189,000 and $46,440,000, respectively. Doubtful accounts against which provisions of $7,643,000 had previously been made were written off during 2000. The charge to doubtful accounts was $9,392,000, $8,497,000 and $9,464,000 for the years ended December 31, 2000, 1999 and 1998, respectively.
13. Commitments and Contingent Liabilities
(a) On January 31, 2001, the Company received notice of a lawsuit filed in the United States District Court for the Southern District of New York against Terra Nova by Palladium Insurance Limited and Bank of America, N.A. seeking approximately $27 million plus exemplary damages in connection with alleged reinsurance agreements. The Company believes it has numerous defenses to these claims, including the defense that the alleged reinsurance agreements were not valid. The Company intends to vigorously defend this matter, however, it cannot predict the outcome at this time.
The Company has other contingencies that arise in the normal conduct of its operations. In the opinion of management, the resolution of these contingencies are not expected to have a material impact on the Company's financial condition or results of operations.
TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(b) The Company entered into various lease agreements for office space. Certain leases have options permitting renewals for additional periods. As well as minimum fixed rentals, certain leases contain escalation clauses related to the cost of living in future years. The future minimum aggregate rental commitments for office space at December 31, 2000, under non-cancelable operating leases are as follows:
Rental expense on property leases of $5,057,000, $4,467,000 and $4,246,000 was incurred for the periods to December 31, 2000, 1999 and 1998, respectively.
14. Extraordinary Charge Arising on Extinguishment of Debt
An extraordinary charge of $11.6 million arose during the second quarter of 1998 as a result of Markel International extinguishing all of its $100 million 10.75% Senior Notes due 2005 (the "Senior Notes"). The charge was net of a $5.2 million income tax benefit.
The Senior Notes were extinguished as follows:
(a) On April 1, 1998, Markel International repurchased $4.5 million of the Senior Notes for consideration of $5.2 million, including accrued interest. (b) On May 18, 1998, Markel International completed a cash tender for the remaining $95.5 million of the Senior Notes for consideration of $111.9 million, including accrued interest.
The extraordinary charge has been recognized in the period of extinguishment under SFAS No.125 "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities".
15. Long-Term Debt
The Company's total outstanding consolidated indebtedness at December 31, 2000, was made up of $100 million of 7.0% Senior Notes due 2008, issued in 1998, and $75 million 7.2% Senior Notes due 2007, issued in 1997. The estimated fair value of these Senior Notes at December 31, 2000, was $161.1 million, comprising $91.2 million of 7.0% Senior Notes due 2008 and $69.9 million of 7.2% Senior Notes due 2007.
The Senior Notes were issued by Markel International and are guaranteed fully and unconditionally by Bermuda Holdings. The Senior Notes may be redeemed at any time at the option of Markel International at a redemption price equal to the sum of: (i) the principal amount of the Senior Notes being redeemed plus accrued interest to the redemption date; and (ii) the make-whole amount, if any.
16. Segment Information
On March 24, 2000, the Company was acquired by Markel. As a result, Markel realigned its operations with the Company becoming its international division.
The Company's operating segments have been changed in accordance with this realignment. The Company now includes three operating segments: the London Company Market, the Lloyd's Market and Investing. All
TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
investing activities are included in the Investing operating segment. Discontinued programs and non-strategic insurance subsidiaries are included in Other for purposes of segment reporting.
The Company considers many factors including the nature of the underwriting units' insurance products, production sources, distribution strategies and regulatory environment in determining how to aggregate operating segments.
Segment profit or loss is measured by underwriting profit or loss. Segment profit for the Investing operating segment is measured by net investment income and realized net gains or losses.
The Company does not allocate assets to the operating divisions for management reporting purposes. The total investment portfolio and cash and cash equivalents are allocated to the Investing operating segment. The Company does not allocate capital expenditure for long-lived assets to any of its operating segments for management reporting purposes.
(a) The table below summarizes the segment disclosures for the years ended December 31, 2000, 1999 and 1998. Prior year amounts have been reclassified to conform with the current year presentation.
TERRA NOVA (BERMUDA) HOLDINGS LTD. AND SUBSIDIARIES
Notes to the Consolidated Financial Statements (continued)
(b) The table below reconciles segment (loss) profit to the Company's consolidated financial statements.
17. Statutory Financial Data
(a) Terra Nova files an annual audited return with the Financial Services Authority (the "FSA"), in the U.K. The regulations require U.K. insurance companies to comply with prescribed minimum solvency margins. Assets and liabilities reported within the annual FSA Return are prepared subject to specified rules concerning valuation and admissibility. Consequently, net assets reported within the Return may vary from net assets as they appear in Terra Nova's published financial statements. Technical provisions shown in Terra Nova's annual FSA Return reflect the statutory requirement in the U.K. for insurance companies to maintain equalization provisions. Equalization provisions are established in accordance with specified rules and are in addition to the provisions required to meet the anticipated ultimate cost of settlement of outstanding claims at the balance sheet date. Such provisions are not required under U.S. GAAP.
A reconciliation of total technical provisions (excluding provision for unearned premiums) reported in Terra Nova's annual FSA Return, to Terra Nova's reserve for unpaid losses and loss adjustment expenses under U.S. GAAP for the years ended December 31, 2000, 1999 and 1998, is provided below:
Terra Nova's unaudited required minimum statutory solvency margin and unaudited statutory solvency margin at December 31, 2000, were $35,529,000 and $105,322,000, respectively. Terra Nova's unaudited and estimated FSA Return policyholders' surplus and unaudited net income for the year ended December 31, 2000, and the audited FSA Return policyholders' surplus and net income as reported in the annual returns to the FSA for the years ended December 31, 1999 and 1998, are as follows:
Terra Nova's ability to pay dividends is limited by a Notice of Requirements issued by the FSA which requires Terra Nova to give 14 days' advance notice to the FSA of its intention to declare and pay a dividend. In addition, Terra Nova must comply with the Companies Act 1985 which provides that dividends may only be paid out of distributable profits.
TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
(b) Terra Nova (Bermuda)'s ability to pay dividends is subject to certain regulatory restrictions. Under the Insurance Act of 1978, amendments to it and related regulations of Bermuda (the "Act"), Terra Nova (Bermuda) is required to file in Bermuda statutory financial statements and a statutory financial return. The Act also requires Terra Nova (Bermuda) to maintain certain measures of solvency and liquidity during the year.
Terra Nova (Bermuda) ceased accepting new business on April 2, 2000. On September 15, 2000, Terra Nova (Bermuda) de-registered as a Class 4 insurer, and obtained approval as a Class 3 insurer.
Terra Nova (Bermuda)'s statutory capital and surplus and minimum required statutory capital and surplus and net income for the years ended December 31, 2000, 1999 and 1998, respectively, were:
(c) Markel Capital must comply with the Companies Act 1985 which provides that dividends may only be paid out of distributable profits.
Bermuda Holdings' and Markel International's ability to meet their expenses and debt services requirements is dependent upon the ability of Terra Nova and Terra Nova (Bermuda) to pay dividends as described above.
18. Summarized Financial Information for Markel International Limited ("Markel International")
Markel International changed its name from Terra Nova Insurance (UK) Holdings plc on April 20, 2000. On November 3, 2000, Markel International was re-registered as a private limited company. Accordingly, the name was changed to Markel International Limited and the status of the company changed to private with effect from that date.
Markel International's summarized consolidated balance sheet information as at December 31, 2000, and December 31, 1999, and summarized consolidated statement of operations information for the year ended December 31, 2000, and 1999, is set out below.
Markel International is the issuer of $75 million 7.2% Senior Notes due 2007 and $100 million 7.0% Senior Notes due 2008. The Senior Notes are guaranteed fully and unconditionally by the Company.
TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
19. Unaudited Selected Quarterly Financial Data
20. Derivatives
The Company enters into forward foreign exchange contracts to hedge foreign currency transactions. Gains or losses from currency rate changes on forward contracts hedging foreign currency transactions are recorded currently in earnings. At December 31, 2000, the Company had entered into contracts with an aggregate notional amount of $45.3 million to buy U.K. sterling. Contract maturities range from June 2001 to June 2002. The effect from foreign currency transactions, including hedging activities was a gain of $4.4 million for the year ended December 31, 2000.
ITEM 9
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Previously reported.
PART IV
ITEM 14
ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS OF FORM 8-K
(a) Index to Financial Statements. The financial statements filed as part of this report are listed in the Index to Financial Statements on page 12.
Index to Financial Statement Schedules - --------------------------------------
Supplemental Schedule II(a)
TERRA NOVA (BERMUDA) HOLDINGS LTD. AND SUBSIDIARIES PARENT COMPANY FINANCIAL INFORMATION (1) CONDENSED BALANCE SHEETS (dollars in thousands)
(1) The parent company condensed financial information should be read in conjunction with the consolidated financial statements, notes and the accompanying reports of independent accountants.
Supplemental Schedule II(b)
TERRA NOVA (BERMUDA) HOLDINGS LTD. AND SUBSIDIARIES PARENT COMPANY FINANCIAL INFORMATION (1) CONDENSED STATEMENTS OF OPERATIONS (dollars in thousands)
(1) The parent company condensed financial information should be read in conjunction with the consolidated financial statements, notes and the accompanying reports of independent accountants.
Supplemental Schedule II(c)
TERRA NOVA (BERMUDA) HOLDINGS LTD. AND SUBSIDIARIES PARENT COMPANY FINANCIAL INFORMATION (1) CONDENSED STATEMENTS OF CASH FLOWS (dollars in thousands)
(1) The parent company condensed financial information should be read in conjunction with the consolidated financial statements, notes and the accompanying reports of independent accountants. (2) Total purchase of new share capital in subsidiary company was $188.0 million in 2000. (3) Total dividends received from subsidiaries were $40.0 million in 2000 and $213.0 million in 1999.
ITEM 14 - EXHIBITS - ------------------
(c) Exhibits
Exhibit Number
3.1 Certificate of Incorporation and Memorandum of Association of the Company (incorporated by reference to Exhibit 3.2 of the Company's Registration Statement on Form S-1, Registration No. 33-93358).
3.2 Amended and Restated Bye-Laws of the Company (incorporated by reference to Exhibit 3.2 of the Company's Registration Statement on Form S-1, Registration No. 333-1726).
4 The registrant hereby agrees to furnish to the Securities and Exchange Commission a copy of all instructions defining the rights of holders of long-term debt of the registrant and subsidiaries shown on the Consolidated Balance Sheet of registrant at December 31, 2000, and the respective Notes thereto, included in this Annual Report on Form 10-K.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
TERRA NOVA (BERMUDA) HOLDINGS LTD
By: Anthony F. Markel President and Chief Executive Officer March 30, 2001
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.