Tokio Millennium Re Ltd. Annual Report Exploring New Horizons

Transcription

1 Tokio Millennium Re Ltd. Annual Report 2003 Exploring New Horizons

2 AM Best rating: A++ (Superior) Standard & Poor s rating: AA- As at December 31, 2003 Total assets: Shareholder s equity: Net income: $825.8m $582.7m $53.8m 1 A new way of thinking 2 Message from the CEO 4 A new way of working 6 Operating Report 10 Financial Highlights 13 Independent Auditors Report 14 Consolidated Balance Sheets 15 Consolidated Statements of Operations and Comprehensive Income 16 Consolidated Statements of Changes in Shareholder s Equity 17 Consolidated Statements of Cash Flows 18 Notes to the Consolidated Financial Statements 27 Historical Financial Information 28 Corporate Information

3 Tokio Millennium Re Ltd. Established in 2000 to act as a pioneer for the whole Tokio Marine group with the wish to prosper for the next millennium. A new way of thinking Japan s largest non-life insurance company, The Tokio Marine and Fire Insurance Company, Limited (Tokio Marine) took a visionary step in 2000, establishing Tokio Millennium Re Ltd. (Tokio Millennium) in Bermuda. Initiated with $125 million in capital, Tokio Millennium quickly grew to become the largest subsidiary in the Tokio Marine group. At the dawn of a new millennium, Tokio Marine embarked on an unprecedented quest to expand its horizons by visionary means. Tokio Millennium is the embodiment of that vision. In all endeavours, Tokio Millennium embraces leading edge expertise and technology. A pioneer in the area of risk diversification, the company has significantly reduced capital costs and increased shareholder value. Ever an agent of change, Tokio Millennium looks to the field of alternative risk transfer (ART) as an additional source of income. Tokio Millennium Re Ltd. 1

4 Endeavouring to create a new market for clients and provide value by utilisation of the company s high expertise and globalisation. Message from the CEO To Our Clients, Tokio Millennium was established in Bermuda in March 2000, the year of the millennium from which its name originates. The company s capital ($500 million) has been invested solely by Tokio Marine, with its desire as a primary insurer to realise the aspiration of creating a new market for insurance consumers around the world. Since its establishment four years ago, Tokio Millennium has contributed to the strengthening of worldwide reinsurance capacity by providing natural-perils coverage for insurance and reinsurance companies through innovative reinsurance and derivative products. The company has also facilitated risk-swap transactions, enabling companies to enhance capital efficiency through diversification of worldwide natural-peril exposures. In other areas, Tokio Millennium has provided structured products to protect clients from contingent events. The reinsurance market has faced severe challenges since the tragic attack on the World Trade Center, however, Tokio Millennium has overcome these challenges and has steadily grown and developed by utilising its high credit ratings and large capacity. 2 Exploring New Horizons Annual Report 2003

5 pictured above: Shin-ichiro Okada President & Chief Executive Officer In 2003, the company wrote premium income of $103 million and generated a net profit of $54 million. Since the company s inception, capital has increased from $125 million to $500 million following successive capital injections from its parent company, and cumulative net profits stand at $90 million. However, we do not consider the level of profit the sole measure of the company s performance. Tokio Millennium is managed as a strategic element of the Tokio Marine group in order to expand long-term stable capacity to the world insurance and reinsurance markets. We believe that accepting risks with high volatility, such as natural perils, requires abundant capital to support those risks, thus providing long-term, stable capacity. Tokio Millennium takes conservative measures to ensure the sound use of its capital, an approach that is highly regarded by our credit-rating agencies. Tokio Millennium s ROE was 9.6 percent in While not at the high level of many of our peers, this reflects the conservative approach we take in the use of our capital. Even after a catastrophic event that might devastate the reinsurance market, our approach would leave us with enough capital to provide the same capacity to our clients as we do today. Shin-ichiro Okada President & Chief Executive Officer Tokio Millennium Re Ltd. 3

6 UK/Europe 47% USA 35% Australia/NZ 13% Taiwan 3% Turkey 2% Tokio Millennium Re Ltd. Hamilton, Bermuda Geographical Spread of Risk Tokio Millennium Re Ltd. Enhancing the capital efficiency of Tokio Marine Group by diversifying geographically the aggregation of natural perils currently concentrated in Japan. A new way of working Diversifying Risk Tokio Millennium s parent company, Tokio Marine *, has an extensive business network around the world with offices in 51 cities in 31 countries. However, the group s natural catastrophe risk exposures have been concentrated across Japan. Tokio Millennium s mission is to act as a strategic risk diversifier for the Tokio Marine group, by writing high layer natural catastrophe risks outside of Japan. 4 Exploring New Horizons Annual Report 2003

7 Diversifying Risk Sharing Knowledge Tokio Marine and Fire Insurance Co., Ltd. Tokyo, Japan Advanced risk analysis, capital management, transactional skills and a large capital commitment allow Tokio Millennium to pursue this mission. Sharing Knowledge Bermuda has become one of the world s leading reinsurance markets with a substantial capacity for all major lines of business, in particular, natural catastrophe and ART products. Tokio Millennium s other role within the Tokio Marine group is to strengthen its expertise in this ART market and to share the knowledge gained with the entire group so that similar products can be marketed to our Japanese clients. * The Tokio Marine and Fire Insurance Company, Limited is a core subsidiary of Millea Holdings, Inc. (MLEA), which offers non-life, life, risk management and other services including financial and investment management. In October 2004, Tokio Marine will merge with Nichido Fire and Marine Insurance Company, making the new, merged company by far the largest in terms of profitability and size among non-life companies in Japan. Tokio Millennium Re Ltd. 5

8 Satisfying our worldwide clients through constant pursuit of leading edge insurance and financial technology expertise. Operating Report Our primary operating mission is to provide catastrophe risk management products for insurance and reinsurance clients around the globe. We do this with an emphasis on quantitative risk management techniques. Within the world of catastrophe risk management, we currently engage in two areas of business: traditional natural catastrophe products and structured reinsurance products. For traditional natural catastrophe products, we target non-japanese risks with an average return period of 100 years. For structured reinsurance products, we focus on providing out-of-the-money transactions with very low loss probabilities and high severity impacts. These lines of business are different, yet they share the value of carefully calculated risk management across our balance sheet. This combined risk portfolio enables us to achieve a significant risk-diversification benefit over the long run when constructed in a careful manner with appropriate capital-management tools and a shareholder who is focused on long-term results. 6 Exploring New Horizons Annual Report 2003

9 pictured above: Yuichi Takeda Chief Operating Officer Dealing with a multitude of catastrophic risks requires a consistent assessment at both a transactional and portfolio level. Our proprietary capital-management tool, Tokio Millennium Risk Optimization Window (TMROW ), is an integral part of our daily operations. We model every transaction in order to realise a diversification benefit and we monitor our entire economic risk capital, which must stay below a predetermined threshold of our net assets. Our operation stands on the thorough understanding of primary insurance operations. We are committed to engage in transactional innovation on behalf of our clients and shareholder. We are consistent in our approach towards risk and only involve ourselves in areas of our expertise. This sound rationale has led to steady growth since our establishment. In order to ensure that this growth continues, we are committed to building an advanced business infrastructure while keeping the number of dedicated staff to a minimum. We continue to invest in best practice for our operations by engaging expert services from legal, compliance, actuarial, auditing and IT consultants. Tokio Millennium sincerely hopes our operational discipline, together with our strong rating, gives our clients significant comfort in their desire to manage their risk exposure. Tokio Millennium Re Ltd. 7

10 Operating Report continued Underwriting Overview Our mission of geographically diversifying risk is achieved by accepting non-japanese property catastrophe excess of loss reinsurance business and by investing in catastrophe bonds. We strengthen our expertise in the ART market by continuing to grow our ART portfolio, writing structured reinsurance products and transforming derivatives to reinsurance Underwriting Results Overall, net written premium grew 191 percent and net earned premium by 109 percent to stand at $100 million and $55.9 million respectively. These increases arise as a result of the utilisation of the additional capital injected in Fee income from structured reinsurance rose substantially to stand at $9.4 million as we continue our expansion into this market. Total underwriting income for the year was $69.1 million, an increase of 116 percent. An improved loss performance resulted in a loss ratio of 25 percent, down from 86 percent the previous year. The combined loss and total expenses ratio dropped to 59 percent from 109 percent. pictured left to right: Edwin Jordan Senior Vice President, Tatsuhiko Hoshina Director & Chief Underwriting Officer, Yoko Hansen General Administrator & Secretary, Simon Arnott Vice President This resulted in a net underwriting profit of $41.9 million. 8 Exploring New Horizons Annual Report 2003

11 Traditional Catastrophe Reinsurance The strength of the company is the security and large capacity we provide to our clients. Our growth has been aided by the market s increasing shift to high-quality security. Many of our transactions are private layers where the placements are not shown in the open market; as a result, we are often the sole reinsurer. Our extensive research and expenditure on internal and external pricing-model tools enable us to control conservatively both territorial and peril accumulations while maximising returns on utilised capital. Underwriting is concentrated in territories where we believe the data is more reliable and the catastrophe modelling more robust. The territorial breakdown of our portfolio is shown on page 4. Our goal is to build significant, long-term relationships with insurers and reinsurers and provide them with first-class security for their major natural-peril catastrophes. Catastrophe Bonds Tokio Millennium has a total of $49 million invested in catastrophe bonds. In terms of risk accumulation, the investment is managed as though the exposure forms part of our traditional catastrophe reinsurance portfolio. Risk Swaps In June 2003, Tokio Millennium established a subsidiary, Tokio Millennium Agency Ltd. This subsidiary negotiates and administers property catastrophe risk swap transactions on behalf of Tokio Marine. The total aggregate swapped in 2003 was in excess of $1 billion. Tokio Marine s Japanese earthquake and typhoon exposure is swapped with non-japanese natural-peril exposure from insurance and reinsurance companies. As of July 2003, the swaps are solely between Tokio Marine and the counterparties. Prior to this, Tokio Millennium participated as a co-reinsurer with Tokio Marine. Structured Products The current portfolio consists of whole account stop loss, structured quota share and working-layer US corporate workers compensation contracts. We seek to write a limited number of contracts each year that are substantial in size and have a low correlation with our traditional catastrophe reinsurance portfolio. Tokio Millennium Re Ltd. 9

12 The company s financial assets are held in a conservative investment portfolio, with a focus on income and asset protection. Financial Highlights Shareholder s Equity In millions of US dollars Net Earned Premium In millions of US dollars Net Income In millions of US dollars 10 Exploring New Horizons Annual Report 2003

13 pictured above: Kunihiko Fujii Chief Financial Officer Results 2003 has been our most profitable year to date. As a result of continued business growth, total income increased by $43.6 million from the previous fiscal year to stand at $86.7 million. Total income consists of net property catastrophe premiums earned of $55.9 million, structured reinsurance fees of $9.4 million, catastrophe bond income of $3.8 million, agency fees of $0.1 million and net investment income of $17.5 million. Net investment income increased by 58 percent from the previous fiscal year. This increase is accounted for by a capital injection of $250 million in the 2nd quarter of 2002, as well as the transition to fixed maturity securities from cash equivalents, which was completed by the 1st quarter of Total expenses amounted to $32.9 million, an increase of $3.8 million from the previous fiscal year. Total expenses consist of net losses incurred of $14.1 million, acquisition expenses of $11.7 million, catastrophe derivative expenses of $1.4 million, general and administrative expenses of $7 million and foreign exchange gains of $1.3 million. As a result, net income increased by $39.7 million from the previous fiscal year to $53.8 million this year. Other comprehensive income, consisting of net changes in unrealised gains/(losses), amounted to ($5.5) million for the year. Investment assets, consisting of cash and cash equivalents and fixed maturity securities, amounted to $550.9 million, an increase of $42.1 million from the previous fiscal year. Total assets increased by $96.3 million to stand at $825.8 million. Retained earnings increased by $37.6 million to stand at $70.1 million at year-end. The increase results from net income for the year of $53.8 million, less a proposed dividend of $16.1 million. Accumulated other comprehensive income stands at $12.7 million. Shareholder s equity increased by 6 percent to stand at $582.7 million at year-end. Tokio Millennium Re Ltd. 11

14 Financial Highlights continued pictured above: Veronica Lewis Accounts Administrator Maurice Kane Vice President & Financial Controller Investment Portfolio The year 2003 saw the completion of our transition from a cash-based portfolio to a fixed maturity bond portfolio. The bond portfolio primarily consists of US government securities with a weighted average credit rating of AAA. The minimum credit rating is AA-. At year-end, the average maturity of the bond portfolio stood at 4.4 years, and the average duration stood at 3.8 years. The balance of our investment portfolio is held in AAA rated money-market funds and cash deposits. d c e b f a 2003 Investment portfolio US$ 000 a US treasuries & agencies 348,762 b Non-US treasuries & agencies 31,172 c US corporates 20,930 d Non-US corporates 46,743 e Asset-backed securities 21,150 f Cash and cash equivalents 82, , Exploring New Horizons Annual Report 2003

15 Ensuring ethical business conduct and strict compliance with all applicable laws and regulations is the cornerstone of our operation. Consolidated Financial Statements Independent Auditors Report We have audited the accompanying consolidated balance sheets of Tokio Millennium Re Ltd. and subsidiary as at December 31, 2003 and 2002 and the related consolidated statements of operations and comprehensive income, changes in shareholder s equity and cash flows for the years then ended. These financial statements are the responsibility of the company s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated 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 Tokio Millennium Re Ltd. and subsidiary as at December 31, 2003 and 2002, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. Chartered Accountants Hamilton, Bermuda February 27, 2004 Tokio Millennium Re Ltd. 13

16 Consolidated Balance Sheets As at December 31, 2003 and Note US$ 000 US$ 000 Assets Cash and cash equivalents 3 82, ,951 Fixed maturity securities 4 468, ,848 Catastrophe bonds 4 49,406 49,245 Deposit asset 3 134, ,961 Accrued interest receivable 6,501 4,533 Reinsurance balances receivable 17,215 15,867 Prepaid reinsurance premiums 2, Catastrophe swap, at fair value 131 Outstanding losses recoverable from reinsurers Deferred acquisition expenses 22,787 1,883 Prepaid expenses Capital assets 7 1,074 1,176 Funds withheld 3 39, Other assets Total assets 825, ,514 Liabilities Outstanding losses and loss expenses 5 13,660 2,490 Deposit liability 134, ,961 Reinsurance balances payable 4,935 Unearned premiums 66,010 19,781 Deferred fee income 6,558 5,987 Accounts payable and accrued expenses 1, Dividend payable 16,129 4,212 Total liabilities 243, ,933 Shareholder s equity Authorised, issued and fully paid, 100,000,000 shares of $1 par value each 100, ,000 Contributed surplus 8 400, ,000 Retained earnings 70,053 32,417 Other comprehensive income 12,690 18,164 Total shareholder s equity 582, ,581 Total liabilities and shareholder s equity 825, ,514 See accompanying notes to consolidated financial statements. Signed on behalf of the Board; Director Director 14 Exploring New Horizons Annual Report 2003

17 Consolidated Statements of Operations and Comprehensive Income For the years ended December 31, 2003 and Note US$ 000 US$ 000 Income Reinsurance premiums assumed 103,804 42,869 Change in unearned premiums (46,229) (7,689) Reinsurance premiums earned 57,575 35,180 Reinsurance premiums ceded 6 3,789 8,451 Change in prepaid reinsurance (2,066) (19) Reinsurance premiums ceded 1,723 8,432 Net premiums earned 55,852 26,748 Catastrophe bond income 3,786 3,840 Fee income 9,351 1,444 Agency fee income 133 Total operating income 69,122 32,032 Net investment income 4 17,540 11,075 Total income 86,662 43,107 Expenses Loss and loss expenses incurred 14,496 23,205 Losses recoverable from reinsurers (422) (204) Net loss and loss expenses incurred 5 14,074 23,001 Acquisition expenses 11,740 1,102 Catastrophe swap expense 1,373 General and administrative expenses 7,044 5,176 Foreign exchange gain (1,334) (214) Total expenses 32,897 29,065 Net income 53,765 14,042 Other comprehensive (loss)/income Net change in unrealised (loss)/gains on investments (5,474) 18,164 Other comprehensive (loss)/income (5,474) 18,164 Comprehensive income 48,291 32,206 See accompanying notes to consolidated financial statements. Tokio Millennium Re Ltd. 15

18 Consolidated Statements of Changes in Shareholder s Equity For the years ended December 31, 2003 and Note US$ 000 US$ 000 Share capital Balance at beginning and end of year 100, ,000 Contributed surplus Balance at beginning of year 400, ,000 Change for the year 8 250,000 Balance at end of year 400, ,000 Retained earnings Balance at beginning of year 32,417 22,587 Net income 53,765 14,042 Dividends (16,129) (4,212) Balance at end of year 70,053 32,417 Other comprehensive income Balance at beginning of year 18,164 Net change in unrealised gains on investments (5,474) 18,164 Balance at end of year 12,690 18,164 Total shareholder s equity 582, ,581 See accompanying notes to consolidated financial statements. 16 Exploring New Horizons Annual Report 2003

19 Consolidated Statements of Cash Flows For the years ended December 31, 2003 and US$ 000 US$ 000 Cash flows from operating activities Net income 53,765 14,042 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation of capital assets Amortisation of fixed maturity securities 4,449 1,901 Gain on sale of fixed maturity securities (28) Deposit asset 11,312 (145,961) Accrued interest receivable (1,968) (3,038) Reinsurance balances receivable (1,348) (5,854) Prepaid reinsurance premiums (2,066) (19) Catastrophe swap, at fair value (131) Outstanding losses recoverable from reinsurers (115) 525 Deferred acquisition expenses (20,904) (1,034) Prepaid expenses (158) (18) Funds withheld (38,773) 140 Other assets 27 (103) Outstanding losses and loss expenses 11, Deposit liability (11,312) 145,961 Reinsurance balance payable 4,935 (273) Unearned premiums 46,229 7,688 Deferred fee income 571 5,987 Accounts payable and accrued expenses Deferred option premium (361) Cash provided by operating activities 56,513 20,232 Cash flows from investing activities Purchase of fixed maturity securities (218,837) (700,132) Proceeds on maturity of fixed maturity securities 31, ,303 Proceeds on sale of fixed maturity securities 22,446 Purchase of catastrophe bonds (10,000) Purchase of capital assets (145) (280) Cash used by investing activities (165,111) (308,109) Cash flows from financing activities Contributed surplus 250,000 Dividend paid (4,212) Cash (used by)/provided by financing activities (4,212) 250,000 Net decrease in cash and cash equivalents (112,810) (37,877) Cash and cash equivalents at beginning of year 194, ,828 Cash and cash equivalents at end of year 82, ,951 See accompanying notes to consolidated financial statements. Tokio Millennium Re Ltd. 17

20 Notes to the Consolidated Financial Statements For the years ended December 31, 2003 and General Tokio Millennium Re Ltd. (the Company ) was incorporated under the laws of Bermuda on March 15, 2000 and is licenced as a Class 3 reinsurer under the Insurance Act, 1978 of Bermuda and related regulations to write all classes of property and casualty business. The Company is a wholly-owned subsidiary of the Tokio Marine and Fire Insurance Company, Limited. The Company participates in various excess of loss property catastrophe reinsurance contracts. Property catastrophe reinsurance covers unpredictable events such as hurricanes, windstorms, hailstorms, earthquakes, fires, industrial explosions, freezes, floods and other man-made or natural disasters. Because the Company has large aggregate exposures to these risks, the Company expects that its claims experience will be characterised by relatively low frequency and high severity claims. The occurrence of claims from catastrophic events is likely to result in substantial volatility in the Company s financial results for any particular period. The Company endeavours to manage its exposures to catastrophic events by limiting the amount of its exposure in each geographic zone. The Company also provides non-traditional customised insurance, reinsurance and financial solutions for its clients world-wide property and casualty exposures on both a treaty and facultative basis. On June 6, 2003 Tokio Millennium Agency Ltd. ( TMA ), a wholly-owned Bermuda subsidiary of the Company, was incorporated with an initial share capital of $12,000. Its primary activity is to facilitate risk swap agreements between Tokio Marine and Fire Insurance Company, Limited and other insurance companies for which it receives agency fees. 2. Summary of significant accounting policies The accompanying consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America which require management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The following are the significant accounting policies adopted by the Company: (a) Basis of consolidation These consolidated financial statements include the results of operations of Tokio Millennium Re Ltd. and its wholly-owned subsidiary Tokio Millennium Agency Ltd. All material inter-company balances have been eliminated. (b) Premiums earned and acquisition expenses Premiums assumed are recorded on the accruals basis and are included in income on a pro-rated basis over the period of underlying coverage with the unearned portion deferred in the balance sheet. Reinsurance premiums ceded are similarly pro-rated over the period of coverage with the unearned portion being deferred in the balance sheet as prepaid reinsurance premium. 18 Exploring New Horizons Annual Report 2003

21 Acquisition expenses, mainly commissions and brokerage, related to unearned premiums are deferred and amortised to income over the periods in which the premiums are earned. The method followed in determining the deferred acquisition expenses limits the amount of the deferral to its realisable value by giving consideration to losses and expenses expected to be incurred as premiums are earned. (c) Outstanding losses and loss expenses Losses and loss expenses paid are recorded when advised by the ceding insurance companies. Outstanding losses comprise estimates of the amount of reported losses and loss expenses received from the ceding insurance companies plus a provision for losses incurred but not reported estimated by management, based on actuarial analysis using historical data available to the Company on the business assumed together with industry data. Given the inherent nature of major catastrophic events, considerable uncertainty underlies the assumptions and associated estimated reserve for losses and loss expenses. These estimates are reviewed regularly and, as experience develops and new information becomes known, the reserves are adjusted as necessary. Such adjustments, if any, are reflected in income in the period in which they are determined. Due to the inherent uncertainty in estimating the liability for losses and loss expenses, there can be no assurance that the ultimate liability will not be settled for a significantly greater or lesser amount than that recorded. Based on the current assumptions used management believes that the Company s recorded amount is a reasonable estimate of the ultimate cost of losses incurred to the balance sheet date. Amounts recoverable from reinsurers are estimated in a manner consistent with the underlying liabilities. (d) Investments Investments in fixed maturity securities and catastrophe bonds are classified as available for sale and are carried at fair value with any unrealised gains and losses included in accumulated other comprehensive income as a separate component of shareholder s equity. Fair value is based on quoted market prices. The cost of fixed maturity securities is adjusted for amortisation of premiums and discounts. Realised gains and losses on fixed maturity securities and catastrophe bonds are recognised in net income using the specific identification method and include adjustments for declines in value that are considered other than temporary. Interest income on fixed maturity securities and catastrophe bonds is accrued to the balance sheet date. (e) Option premium income The Company enters into option arrangements in which the Company grants a potential cedant the right to purchase reinsurance from the Company. Option premiums are earned over the option period. Tokio Millennium Re Ltd. 19

22 Notes to the Consolidated Financial Statements continued For the years ended December 31, 2003 and Summary of significant accounting policies (continued) (f) Deposit assets and liabilities In the normal course of its operations, the Company enters into certain contracts that do not meet the risk transfer provisions of Statement of Financial Accounting Standard No. 113, Accounting and Reporting for Reinsurance of Short Duration and Long Duration Contracts. These contracts are accounted for using the deposit accounting method. Generally consideration is retained by the cedant on a funds withheld basis and is recorded as a deposit asset. The Company is credited with interest on the deposit asset at a contractually determined rate. Interest income is recorded in the statement of operations as part of net investment income. The Company initially records a deposit liability in the amount of the consideration due or received. Actuarial analysis is used to estimate the ultimate liability assumed under the contract and the appropriate accretion rates to increase the initial deposit over the contract term. The accretion charge is recorded in the statement of operations as part of net investment income. Losses paid on these contracts are recorded as a reduction of the deposit asset and deposit liability. The Company earns fee income for the provision of these contracts. Fee income is earned based upon the terms of the contracts, with the unearned portion deferred in the balance sheet, as deferred fee income. (g) Derivative financial instruments The Company designates its derivatives based upon criteria established by Statement of Financial Accounting Standard No. 133, Accounting for Derivative Instruments and Hedging Activities ( SFAS 133 ). From time to time the Company enters into catastrophe swaps, under which certain catastrophe reinsurance exposures are ceded to the swap counterparty. Catastrophe swaps are recorded at fair value with changes in fair values recorded in the income statement. At December 31, 2003, the maximum exposure to the credit risk of the counterparty to the swap agreement is $13 million, which is fully collateralised by assets placed in trust by the counterparty. (h) Capital assets Capital assets are stated at cost less accumulated depreciation calculated on a straight-line basis over the estimated useful lives of the assets which are as follows: Computer equipment & software Office equipment Fixture and fittings Motor vehicles Leasehold improvements 3 years 4 years 5 years 5 years Term of lease (i) (j) Translation of foreign currencies Foreign currency assets and liabilities considered monetary items, are translated at exchange rates in effect at the balance sheet date. Foreign currency revenues and expenses are translated at the transaction date exchange rates. Exchange gains and losses are included in the determination of net income. Cash and cash equivalents For purposes of the statements of cash flows the Company considers all deposits with an original maturity of ninety days or less and money market funds which can be redeemed without penalty as equivalent to cash. 20 Exploring New Horizons Annual Report 2003

23 3. Concentration of credit risk As at December 31, 2003 cash and cash equivalents comprise $82.1million (2002 $194.9million) held with three banking institutions. The Company s management evaluates the financial strength and stability of these institutions on a periodic basis. As at December 31, 2003, a deposit asset of $133.5million (2002 $145.0million) is being held in trust by a ceding company with an A.M. Best credit rating of A. As at December 31, 2003, funds withheld of $37.7million (2002 $Nil) are being held in trust by a ceding company with an A.M. Best credit rating of B Investments (a) Fixed maturity securities (i) The amortised cost, fair value and unrealised gains and losses of investments in fixed maturity securities are as follows: Unrealised Unrealised Amortised Cost Gains Losses Fair Value At December 31, 2003 US$ 000 US$ 000 US$ 000 US$ 000 US government and government agency securities 336,614 13,325 (1,177) 348,762 Non-US government and government agency securities 31, (219) 31,172 US corporate securities 20, ,930 Non-US corporate securities 46, (8) 46,743 Asset-backed securities 21, (48) 21, ,473 13,736 (1,452) 468,757 At December 31, 2002 US government and government agency securities 295,929 17, ,848 (ii) For fixed maturity investments held on December 31, 2003 the maturity distribution is as follows: Amortised Cost Fair Value At December 31, 2003 US$ 000 US$ 000 Within one year 30,769 31,143 From one to five years 266, ,409 From five to ten years 159, , , ,757 Tokio Millennium Re Ltd. 21

24 Notes to the Consolidated Financial Statements continued For the years ended December 31, 2003 and Investments (continued) (a) Fixed maturity securities (continued) (iii) The Company s investments in fixed maturity securities carry a weighted average credit rating of AAA, as assigned by Standard & Poor s. The minimum credit rating of securities within the fixed maturity investment portfolio is AA-. (iv) The components of net investment income for the years ended December 31, 2003 and 2002 were as follows: US$ 000 US$ 000 Interest on fixed maturity securities 21,134 9,526 Amortisation of fixed maturity securities (4,449) (1,901) Interest on cash and cash equivalents 950 3,608 Interest on deposit assets, net of accretion of deposit liability Interest on funds withheld 162 Gain on sale of fixed maturity securities 28 Investment expenses (285) (158) Net investment income 17,540 11,075 (v) In the normal course of business, fixed maturity securities and cash with fair values of $38.4 million and $55.6 million at December 31, 2003 and 2002, respectively, were deposited in trust for the benefit of ceding companies. (b) Catastrophe bonds (i) The Company s investments in catastrophe bonds comprise five catastrophe bonds with Standard & Poor s ratings ranging from BB to BB+ and maturities ranging from 2004 to The issuers of these securities have used the proceeds raised to collateralise certain catastrophe reinsurance obligations, namely US hurricane and earthquake risks and European windstorm risks. The investment in these securities is therefore at risk of loss, in whole or in part, if a covered catastrophe occurs. The cost and fair value of catastrophe bonds are as follows: Unrealised Unrealised Amortised Cost Gains Losses Fair Value At December 31, 2003 US$ 000 US$ 000 US$ 000 US$ 000 Catastrophe bonds 49, (5) 49,406 At December 31, 2002 Catastrophe bonds 49, ,245 (ii) The Company earns income on these securities based upon LIBOR plus a fixed rate of interest. 22 Exploring New Horizons Annual Report 2003

25 5. Outstanding losses and loss expenses The summary of changes in outstanding losses and loss expenses for 2003 and 2002 is as follows: US$ 000 US$ 000 Gross balance as of January 1 2,490 2,426 Less reinsurance recoverable (751) (1,276) Net balance at January 1 1,739 1,150 Incurred losses related to: Current year 14,263 2,480 Prior years (189) 20,521 Total incurred 14,074 23,001 Paid losses related to: Current year (359) (542) Prior years (2,660) (21,870) Total paid (3,019) (22,412) Net balance at December 31 12,794 1,739 Plus reinsurance recoverable Gross balance at December 31 13,660 2,490 In 2002, as a result of the change in estimates of insured events in prior years, the Company incurred losses of $20.5 million. In 2001, the Company entered into a reinsurance agreement providing the cedant with $20 million of cover in excess of certain attachment points. The Company was liable for the full limit of loss if the cedant s losses exceed the attachment by $20 million and property reinsurance market losses as reported by the Property Claims Services ( PCS ) exceed $20 billion. As a result of the terrorist attack on the World Trade Center on September 11, 2001 the cedant incurred losses of $20 million above the attachment point. The latest reports obtained from PCS by the Company at December 31, 2001 indicated that property market losses were approximately $16.6 billion. Based upon these industry estimates, the Company did not record a reserve for outstanding losses and loss expenses in respect of this contract at December 31, However, during 2002, the property market loss reported by PCS increased to more than $20 billion, and the Company paid losses of $20 million to the insured. The establishment of the provision for outstanding losses and loss adjustment expenses is based on known facts and interpretation of circumstances and is therefore a complex and dynamic process influenced by a large variety of factors. These factors include the Company s experience with similar cases and historical trends involving claim payment patterns, pending levels of unpaid claims, product mix or concentration, claim severity and frequency patterns such as those caused by natural disasters, fires, or accidents, depending on the business assumed. Tokio Millennium Re Ltd. 23

26 Notes to the Consolidated Financial Statements continued For the years ended December 31, 2003 and Reinsurance Reinsurance contracts do not relieve the Company from its obligations to policyholders. Failure of reinsurers to honour their obligations could result in losses to the Company; consequently, allowances are established for amounts deemed uncollectible. The Company evaluates the financial condition of its reinsurers and monitors concentrations of credit risk arising from similar geographic regions, activities, or economic characteristics of the reinsurers to minimise its exposure to significant losses from reinsurer insolvencies. At December 31, 2003, outstanding losses recoverable from reinsurers in the amount of $Nil (2002 $Nil) and prepaid reinsurance premiums of $2.3 million (2002 $Nil) were associated with a single reinsurer with an A.M. Best credit rating of A. The Company entered into a retrocession contract with its parent during Premiums ceded to the parent in 2003 amounted to $Nil (2002 $7.2 million). No losses were recovered under this contract in 2003 or Capital assets Capital assets comprise: Accumulated Net Book Net Book Cost Amortisation Value Value US$ 000 US$ 000 US$ 000 US$ 000 Fixtures and fittings Office equipment Computer equipment & software Leasehold improvements Motor vehicles , ,074 1, Contributed surplus Contributed surplus represents cash contributed by the shareholder in excess of the issued share capital. 24 Exploring New Horizons Annual Report 2003

27 9. Fair value of financial instruments The following methods and assumptions were used by the Company in estimating fair value disclosures for financial instruments. Cash and cash equivalents: The carrying amounts reported in the balance sheet for these instruments approximate their fair values. Catastrophe bonds: The fair value of catastrophe bonds is based on independent broker quotes. Fixed maturity securities: The fair value of investments in fixed maturity securities is based on quoted market prices. Other assets and liabilities: The fair value of accrued interest receivable, reinsurance balances receivable, derivative at fair value, funds withheld, other assets, reinsurance balances payable and accounts payable and accrued expenses approximates their carrying value due to their short term nature. The estimates of fair values presented herein are subjective in nature and are not necessarily indicative of the amounts that the Company would actually realise in a current market exchange. However, any differences would not be expected to be material. Certain instruments such as prepaid reinsurance, deferred acquisition costs, deposit assets, outstanding losses recoverable from reinsurers, prepaid expenses, capital assets, deposit liabilities, outstanding losses and loss expenses, unearned premiums and deferred fee income are excluded from fair value disclosure. Thus the total fair value amounts cannot be aggregated to determine the underlying economic value of the Company. 10. Commitments (a) On September 1, 2001, the Company entered into an agreement to lease office space. The term of the lease is ten years. Rent for the current year of the contract amounts to $206,913 (2002 $202,020) and this amount will increase by a factor dependent on the Bermuda consumer price index on a yearly basis. Rent is payable in equal monthly installments. (b) The company issued a letter of credit for $20 million in favour of a ceding company. Fixed maturity securities with a carrying value of $30.4 million have been pledged as security for this letter of credit. Tokio Millennium Re Ltd. 25

28 Notes to the Consolidated Financial Statements continued For the years ended December 31, 2003 and Statutory requirements The Company is required by its licence to maintain capital and surplus greater than a minimum statutory amount determined as the greater of a percentage of outstanding losses or a given fraction of net written premiums. At December 31, 2003 the Company is required to maintain a minimum statutory capital and surplus of $15.3 million. Actual statutory capital and surplus is $558.4 million and accordingly there is no restriction on the amount of retained earnings available for the payment of dividends to the shareholder. Actual statutory capital and surplus, as determined using statutory accounting principles, is as follows: 2003 US$ 000 Total shareholder s equity 582,743 Less non-admitted assets: Deferred acquisition expenses 22,787 Prepaid expenses 515 Capital assets 1,074 Statutory capital and surplus 558,367 The Company is also required to maintain a minimum liquidity ratio whereby the value of its relevant assets are not less than 75% of the amount of its relevant liabilities. Relevant assets include cash and cash equivalents, catastrophe bonds, fixed maturity securities, accrued interest receivable, reinsurance balances receivable, funds withheld and other assets. Certain categories of assets do not qualify as relevant assets under the statute. Relevant liabilities are outstanding losses and loss expenses, unearned premiums, deferred fee income, dividends, accounts payable and accrued expenses, net of outstanding losses recoverable from reinsurers and prepaid reinsurance premiums. At December 31, 2003 the Company was required to maintain relevant assets of approximately $79.0 million. At that date relevant assets were approximately $663.0 million and the minimum liquidity ratio was therefore met. 12. Taxation Under current Bermuda law the Company is not required to pay any taxes in Bermuda on either income or capital gains. The Company has received an undertaking from the Minister of Finance in Bermuda that in the event of any such taxes being imposed the Company will be exempted from taxation until the year Exploring New Horizons Annual Report 2003

29 Historical Financial Information For the years ended December 31, 2003, 2002, 2001 and Consolidated Balance Sheets US$ 000 US$ 000 US$ 000 US$ 000 Assets Cash and cash equivalents 82, , , ,526 Fixed maturity securities 468, ,848 Catastrophe bonds 49,406 49,245 39,000 23,500 Deposit asset 134, ,961 Reinsurance balances receivable 17,215 15,867 10,013 3,280 Funds withheld 39, Other assets 34,426 9,212 5,463 3,566 Total assets 825, , , ,872 Liabilities Outstanding losses and loss expenses 13,660 2,490 2,426 Deposit liability 134, ,961 Unearned premiums 66,010 19,781 12,093 4,234 Other liabilities 28,735 10, Total liabilities 243, ,933 15,287 4,637 Shareholder s equity Share capital 100, , , ,000 Contributed surplus 400, , ,000 25,000 Retained earnings 70,053 32,417 22,587 7,235 Other comprehensive income 12,690 18,164 Total shareholder s equity 582, , , ,235 Total liabilities and shareholder s equity 825, , , , (9 months) 2000 Consolidated Statements of Operations US$ 000 US$ 000 US$ 000 US$ 000 Income Net reinsurance premiums written 100,015 34,418 16,815 6,563 Net premiums earned 55,852 26,748 9,335 2,329 Other underwriting income 13,270 5,284 3, Total operating income 69,122 32,032 13,159 2,619 Net investment income 17,540 11,075 7,867 6,203 Total income 86,662 43,107 21,026 8,822 Expenses Net loss and loss expenses incurred 14,074 23,001 2,016 Acquisition expenses 11,740 1, General and administrative expenses 7,044 5,176 3,001 1,581 Other expenses 39 (214) (67) (44) Total expenses 32,897 29,065 5,674 1,587 Net income 53,765 14,042 15,352 7,235 Tokio Millennium Re Ltd. 27

30 Corporate Information Tokio Millennium Re Ltd. Directors Ken Kamikochi Shin-ichiro Okada Shuzo Sumi Fumiaki Namekawa Tatsuhiko Hoshina Auditors KPMG Crown House 4 Par-La-Ville Road Hamilton HM CX Bermuda Bermuda Lawyers Conyers Dill & Pearman Clarendon House 2 Church Street Hamilton HM CX Bermuda 28 Exploring New Horizons Annual Report 2003

31 In exploring new horizons, we continue to invest in the development of our human resources, ensuring expertise is carried through the generations. Tokio Millennium Re Ltd. Parent Company The Tokio Marine and Fire Insurance Co., Ltd. 2-1, Marunouchi 1-Chome Chiyoda-ku Tokyo Japan

32 Tokio Millennium Re Ltd. Tokio Millennium Re Ltd. The Waterfront 90 Pitts Bay Road Pembroke HM 08 Bermuda Tel: (441) Fax: (441)